The red-hot gold miners’ stocks have continued blasting higher this summer on heavy ETF buying by professional money managers. Funds’ ongoing big capital inflows into this market-leading sector have overcome its usual summer seasonal weakness. While gold stocks’ odds-defying record early-summer surge certainly ramps short-term downside risk, this year’s dazzling new gold-stock bull still remains young.
Managing other people’s money is a hard and challenging job. Investors naturally expect and demand healthy returns after entrusting their hard-earned wealth to financial professionals. And if these fund managers fail to deliver, investors are quick to pull their capital and move it elsewhere. So the money-management industry faces staggering pressure to perform. The funds that don’t measure up risk extinction.
The surest way to find the best short-term performance is to chase winning sectors, so most professional money managers are momentum players. When they see outsized gains, they are quick to deploy their investors’ capital to partake. And that’s led them to gold stocks. In the first half of 2016, the flagship HUI gold-stock index rocketed 121.8% higher compared to a mere 2.7% gain in the benchmark S&P 500 index!
With such epic results, even relatively-small gold-stock allocations in portfolios can really boost their overall gains. So following the successful Brexit vote in late June that reversed gold sharply off lows, fund managers started flooding into leading gold-stock ETFs. These capital inflows accelerated into the end of Q2 on window dressing, where fund managers buy a quarter’s winners before they report to their investors.
These money managers believe reporting that their funds own high-performing stocks in their quarterly updates make them look smarter. But window dressing is deceptive, since funds buying a quarter’s best performers at quarter-end didn’t actually reap their big gains! With gold stocks now firmly on fund managers’ radars, their heavy ETF buying continued in the initial days of Q3 as they put new capital to work.
Like most ETFs, gold-stock ETFs track underlying indexes. Thus when a gold-stock ETF sees a big surge of differential buying from fund capital inflows, its shares threaten to decouple from its index to the upside. So to maintain tracking, the ETF managers have to issue enough new ETF shares to offset that excess demand. They then use the proceeds to buy shares in the actual underlying gold stocks they own.
Because 2016’s new gold-stock bull has been driven by heavy fund buying of ETF shares, the gold stocks owned by the leading ETFs have enjoyed the greatest gains. While nearly all the world’s biggest and best gold miners’ stocks are included in these ETFs, the ones that aren’t are really underperforming their peers. For better or worse, ETFs are how most investors and fund managers choose to own gold stocks.
The leading gold-stock ETFs are the GDX VanEck Vectors Gold Miners ETF for the major gold miners, the GDXJ VanEck Vectors Junior Gold Miners ETF for the smaller miners and explorers, and the SIL Global X Silver Miners ETF for the silver miners. The companies that these ETFs own have seen some of the best gains in 2016, as ETFs have to spread their capital inflows proportionally across their holdings.
But is this amazing gold-stock surge sustainable? There’s definitely still vast room left for professional money managers to add gold-stock exposure in these leading ETFs. As of this week, GDX, GDXJ, and SIL had total net assets of just $10.7b, $4.2b, and $0.4b! These are rounding errors compared to the vast sums of capital invested in funds, so overall fund exposure to gold stocks via these ETFs is still close to zero.
All this heavy fund buying in recent weeks has certainly left gold stocks very overbought on a short-term basis. So if the money managers scale back their big capital inflows, that will probably result in a considerable pullback or correction. But from anything beyond a near-term perspective, the gold stocks don’t look toppy at all despite their extraordinary surge so far this year. Their new bull remains quite young.
This first chart encompassing the last few years or so helps put gold stocks’ blistering recent-weeks surge into perspective. It looks at that leading HUI gold-stock index, which is closely mirrored by GDX. Using the HUI for any technical analysis beyond a few months is preferable because this index doesn’t have management fees. GDX’s managers are paid a 0.52%-of-assets fee annually, slowly skewing its results.
The flagship HUI gold-stock index has skyrocketed a truly-astounding 169.9% higher in just 5.6 months since mid-January! That certainly sounds ridiculously extreme in isolation, but context is crucial here. The HUI had been bludgeoned to fundamentally-absurd 13.5-year secular lows in January. The gold stocks were trading as if gold had utterly cratered to $305, yet it was actually 3.6x higher near $1087.
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