Is the GDXJ really killing the market?
29 APRIL 2017
The past few weeks, there has been a lot of fuss about the GDXJ ETF. An Exchange Traded fund issued by Van Eck which aims to track the index of junior gold mining companies. The ETF has always been extremely popular amongst investors as it provided an easy and low-cost access to gaining exposure to the junior gold space.
It didn’t take long before derivative-focused products took off as well, of which the Direxion-products offering a triple leverage on the GDXJ index ETF were very likely the most popular. When Direxion stopped issuing new units amidst a sky-high demand, several key people started to wondering whether or not the GDXJ became too popular.
With a net asset value of several billions, the ETF is definitely large, but it would be highly surprising if the current size (just $4B) would be such a disruptive factor in the mining industry, and the junior gold mining index. At least, that shouldn’t be the case, as the top-5 of GDXJ’s positions have a combined market capitalization of approximately $10B (this excludes the position in the GDX).
Whilst the GDXJ is absolutely popular for the right reasons, one might argue the GDXJ becomes too big compared to the size of the companies it’s investing in.
But perhaps this isn’t a problem at all. In fact, it’s a positive thing, as it means there very clearly is a huge interest from the investing community to gain exposure to junior gold mining companies. An ETF is obviously the easiest and fastest way to get exposure to several companies in ‘one basket’, rather than going through the process to buy the companies separately.
So, even if the GDXJ would close its doors for new investors (by for instance suspending the creation of new units), the money would still flow into the sector, and the issues wouldn’t be solved at all. Only the ‘convenience factor’ would go down. In fact, the best way to solve the current size of the GDXJ is simply to wait for a market correction.
After all, most of the ETF buyers are investors who want to get exposure, but lack the time or resources to really investigate every company and pick the best amongst them. So these will almost per definition also be the investors who’ll sell their GDXJ units during the next correction on the gold market. The majority of those who got into the GDXJ will get out again.
Will this result in a higher volatility on the markets? Sure. But there would be no difference compared to how the market would have reacted if those ETF buyers would have bought the underlying stock. So it essentially is a non-argument. Another non-argument would be to suggest other ETF’s to investors, such as the smaller Sprott Gold Miners Trust. Not only would this just be ‘transporting’ the problem (after all, whether the funds are invested in ETF A or ETF B, the market positions will continue to be bought or sold depending on de market circumstances).
Source: Van Eck
The very best way to deal with this issue is very likely rebalancing the index that’s being tracked by the ETF’s. When the new index will be implemented on June 17th, the total amount of companies the GDXJ can invest in will increase from 48 to 69.
This increases the investment options for GDXJ, but will also have a very negative side effect, as the GDXJ will have to rebalance the portfolio pretty much overnight. It shouldn’t be an issue to liquidate the investment in GDX ($250M+) and use the existing cash resources, but some of the current holdings will have to try to accommodate Van Eck by arranging blocks to avoid their share prices being impacted too heavily.
Source: Toronto Dominion Bank
According to the two previous images from the Toronto Dominion Bank, some of the positions could take a few days to unwind, whilst some of the new positions will result in a tremendous buying pressure in the more illiquid names.
The solution is pretty simple; instead of ‘forcing’ GDXJ to start tracking the renewed index overnight, the Van Eck fund managers should allow themselves a week, or even several weeks to ensure an orderly update without risking to disrupt the market. And if that doesn’t happen: be prepared to take action right before and right after the rebalancing.
Our conclusion: The GDXJ isn’t ‘too big’. Its investment possibilities were ‘too limited’, and with rebalancing the portfolio in June, this issue will be solved.