4 Reasons to Avoid the Market Vectors Gold Miner ETF
One of the most popular ways to get exposure to gold is by buying shares in the Market Vectors Gold Miner ETF (NYSEARCA:GDX). This fund is one of the largest ETFs on the market, with more than $8 billion under management. It holds large positions in Barrick Gold (NYSE:ABX), Newmont Mining (NYSE:NEM), Goldcorp (NYSE:GG), and in several other large mining companies. As somebody who is bullish on the price of gold, it would seem like an excellent way to profit from rising gold prices.
Unfortunately this is not the case. True, if the gold price rises substantially, I believe that GDX shares will benefit. However, there are several issues with this fund that lead me to believe that there are better ways for investors to get exposure to the gold price. Let us look at some of these issues.
First, like many ETFs, the fund overweights the largest companies. Larger companies aren’t necessarily bad investments, but there is a greater chance that more highly valued companies are overvalued.
Second, I think the fund holds many stocks that simply aren’t good investments. Gold mining is a difficult industry, and there are several companies in the industry that have been poorly managed. This is evidenced by the fact that many gold miners have barely gained in value since the beginning of the gold market at the beginning of the century.
Many companies have tried to grow the number of ounces they produce without regard for profitability or other risks, such as balance sheet risk and geopolitical risk, and as a result they have failed as investments. While some are getting their acts together, I think that many of them aren’t, and investors should take the time to figure out which companies are growing their production responsibly by keeping their costs and debt loads down.
Third, many gold mining companies operate in dangerous parts of the world, and the GDX doesn’t discriminate against these companies. A gold mine that is located in Egypt or South Africa can be very profitable to operate but at the same time its owner faces a heightened risk of confiscation, labor issues, windfall profit taxes, and other value-destroying phenomena. While there are cases in which these mines are worthwhile investments, they need to be cherry-picked through proper analysis. Investors who don’t want to put in this sort of work should not expose themselves to such complex risks.
Fourth, many gold mining companies mine other metals such as copper, nickel, lead, and silver. While these commodities may be good investments, there are different reasons for owning them if they are worth owning. For instance, a lot of investors aren’t aware that Barrick Gold has been increasing its copper production and decreasing its gold production over the past few years.
While there aren’t many pure gold miners, there are several that come close. Investors looking to invest in a gold miner can easily take a few minutes to look at a company’s presentation or at its financial statements in order to determine how much gold it mines.
With these points in mind, investors should look for other opportunities in order to get exposure to the gold market. Here are some suggestions.
First, if you want to own gold, then buy gold. While this sounds redundant, I think it is a key piece of advice. There is no need to complicate things by owning mining companies. In order to justify owning gold, you just need to know the fundamental case for owning it.
Mining companies have all sorts of other factors besides the gold price — geopolitical risk, production costs, quality of capital management, and so on. There are plenty of ETFs that give you exposure to the gold price, from the highly liquid SPDR Gold Trust (NYSEARCA:GLD) to the less liquid yet less expensive Sprott Physical Gold Fund (NYSEARCA:PHYS).
Second, if you want to own gold miners, focus on those companies that don’t have the problems I mention here. Buy a low-cost producer that has production growth and that operates in a low-risk jurisdiction. Research the other metals that the company produces. There are some very interesting options out there such as IAMGOLD (NYSE:IAG), which operates a niobium mine in Quebec — Niobec — in addition to its gold operations.
Niobium is used in small quantities to reinforce steel, and demand for niobium is growing faster than demand for steel. Furthermore, there are just three niobium mines in the world. Having niobium as a secondary metal is an intriguing proposition relative to having copper as a secondary metal.
Ultimately the GDX is not a fund I think investors should own. Not only are there better ways to own gold, but the GDX is endemic of the fact that ETFs are making it easier for investors to access a sector of the economy without really understanding the business model. Sure, buying GDX is easier than making a decision that one mining company is superior to another, but there is a lot of value in that decision, which is evidenced from the vast array of past performances of gold miners.
Some have been flat over the past decade, while gold has tripled. Others have gained hundreds of percentage points, if not thousands. With this disparity in mind, the value of learning to pick quality gold mining companies or the value of simply owning gold is clearly present.
Disclosure: Ben Kramer-Miller is long shares of Goldcorp.