GDX Or GDXJ: Which One To Choose?

Adding what is deemed to be the ultimate safe heaven asset – gold to one’s portfolio is a logical choice in the current uncertain economic environment, exacerbated by geopolitical tensions. Naturally, gold equities could offer leverage on the metal’s price so there’s an even bigger potential reward through gaining gold exposure through mining companies. But there are also bigger risk, so diversification within the sector should be considered. Two of the most popular instruments for that purpose are the VanEck Vectors Gold Miners ETF (NYSEARCA:GDX) and the VanEck Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ). Initially, I thought that GDXJ could have an advantage over GDX in a gold bull market. However, performance from July 2018 to July 2020 suggests that this is not true. In addition, GDX pays higher dividend and its constituents are less likely to face funding challenges. A sudden inflow of institutional money into the gold space could also be tilted towards large-cap companies. For these reasons, I find GDX to be the better ETF for gold exposure.

The macro picture

The worldwide economic and geopolitical environment is full of uncertainty. In light of this, the natural appetite for safe heaven assets is on the rise. Central banks as well as private investors are accumulating the yellow metal at an elevated pace. As a result, 2022 was a record year for central bank’s net purchases as more than 1,136 tonnes were accumulated according to data from the World Gold Council.

One of the reasons for the sudden jump in gold purchases, besides inflation, could be the aftermath of Russia being cut-off from SWIFT and the assets of the Russian central bank held in the US being frozen. Taking a note from this unprecedented event, maybe some central banks thought that it’s wise to diversify their reserves into something that no one has the power to control – gold.

Even the rising interest rate environment seems to not be able to suppress the gold price. At the same time, there’s already a slowdown in the pace of rate hikes in the US and I won’t be surprised if easing follows towards the end of 2023 in case of worsening economic conditions. Such a scenario could lead to considerable pressure to the upside in gold.

Overview of GDX and GDXJ

GDX is designed to track the NYSE Arca Gold Miners Index, while GDXJ aims to replicate the performance of MVIS Global Junior Gold Miners Index. Both funds don’t have a full replication mandate, as they should invest at least 80% of its assets in the constituents of the respective indexes, which leaves some leeway to management. A very similar characteristic of both ETFs is their expense ratio, which is only by 0.01% higher in absolute terms for GDXJ at 0.52%.

On the other hand, due to nature of the indexes that they follow, GDX is invested into larger cap companies, which are also roughly half of the constituents of GDXJ as a total number. The overlap between the two funds is 31.82% as of February 2023. It’s important to note, especially for income oriented investors, that GDX has roughly 2.5 times higher dividend yield. Both funds distribute cash to their shareholders once a year.

Taking a closer look at the top 10 holdings of the ETFs, the highest concentration of GDX is evident. Its largest two positions are the two biggest precious metals producers – Newmont (NEM) and Barrick Gold (GOLD). The presence of royalty and streaming giants – Franco-Nevada (FNV) and Wheaton Precious Metals (WPM) should also be noted with a combined weight of more than 14.5% of AUM. Unlike a typical miners, they have the overwhelming majority of their expenses fixed, giving them cost inflation-protection features. Because of their lower risk profile, they naturally trade at higher multiples than miners. For comparison, these royalty and streaming giants are not included in GDXJ. This could explain to an extent the slightly higher P/E ratio of GDX of 22.13, compared to 19.57 for its junior counterpart.

When it comes to GDXJ it includes smaller companies as it name might suggest, especially outside its top 10 holdings. Some of those companies, for example Skeena Resources (SKE) are still developers and currently don’t have cash generating assets.

Size implications

The size differential has some important implications. Larger companies tend to have more already operating assets, which are generating cash flows. At the same time, smaller companies generally have larger portion of their assets still in development. Take the example of Aris Mining (OTCQX:TPRFF), which has one asset in full operation, one in expansion and two in development. This discrepancy in company maturity allows GDX to maintain higher dividend yield than its counterpart.

On the other hand, it’s logical to assume that development assets are priced at higher discounts to their estimated NPVs, therefore offering some upside when put into operations. But in reality, this might also be a drag – long permitting times and elevated cost inflation is hurting the economic profiles of those projects as the timing to cash flow is delayed and initial CAPEX increases substantially.

Another important point is financing. The raising interest rates environment increases the cost of capital, therefore GDXJ constituents will have harder time financing as on average they don’t generate as much cash flows as GDX members, making internally generated capital a smaller part of the equation at the expense of outside capital. Such an environment could allow royalty and streaming giants and GDX members – WPM and FNV to strike lucrative deals.

Performance comparison

Looking at long-term historical period of 10 years it appears that both ETFs have underperformed both the price of Gold and the broad market, represented by the SPDR S&P 500 Trust ETF (SPY). Still, GDX although posting negative return has done better than GDXJ. But the last 10 years have overall been bad for gold and gold stocks. So if an investor believes in the gold bull thesis, given the macro and geopolitical picture, exposure to the yellow metal should be considered. In that case, it makes sense to check the performance of the two gold ETFs in a bull market. Unfortunately, the funds were not available for the full length of the multi-year bull-run that ended in 2011, so for that reason, I’ll use the gold price increase between 18 July 2018 and 7 July 2020 to assess the difference in return.

The result indicates, that in a gold bull market, both GDX and GDXJ outperform both the price of gold and the broad market. However, the ETF with the larger cap tilt – GDX seems to have done better than its junior peer. This is exactly the opposite of my initial thought that smaller companies, while more risky, should do better in an upward trending precious metals market. One possible explanation of the actual result could be that since the gold space is relatively small to other sectors, the vast majority of gold miners are too small for large institutional players who want to get exposure in the space. Therefore, they flock to the few US$10B+ market caps in the space, which are members of GDX, but not of GDXJ.

Takeaway

Looking at the last 10 years, gold and miners have considerably underperformed the broad market. However, with economic uncertainty and geopolitical tensions brewing, the sector may be set to become popular again. A direct comparison between the characteristics of the two gold ETFs – GDX and GDXJ indicates that the former is a better choice. Even in a gold bull market, larger companies seem to do better than smaller ones, likely on the relatively small size of the sector, pushing institutional money to the few US$10B+ market caps.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.