The Gold Economy

By Brad Zigler

The past few weeks have been bullish for gold, in its bullion form and as an embed in mining stock prices. We’ve touched on the differential volatility of bullion and mining stocks before, most recently in “Appraising Gold Miners’ Equity Risk.” In that piece, we compared the performance and volatility of the Market Vector Gold Miners ETF (GDX) and its components to bullion proxied by the SPDR Gold Shares Trust (GLD).

There’s more than one way to obtain broad exposure to the gold mining sector, though. We, in fact, report on the performance of the GDX portfolio relative to its younger sibling, the Market Vectors Junior Gold Miners ETF (GDXJ) in our Friday “Inflation Scorecard” columns. Some of GDXJ’s components overlap into the GDX portfolio, but the newer fund weights smaller capitalization (read: development and exploration) companies more heavily than producers.

Since its November 2009 launch, the GDXJ fund has outperformed GDX by a 3.5-to-1 margin, albeit with a dollop of extra volatility. That excess variance can be seen readily when you plot the price ratio of the two ETF portfolios. The GDX/GDXJ ratio started life around 2.0 (that is, GDX’s price was roughly twice that of the nascent GDXJ fund’s), but has generally drifted lower since then.

I say “generally” because there have been significant gyrations along the ratio’s downward course. At times, the ratio sinks, meaning GDX’s senior producers lose value relative to the exploration companies. That’s when investors’ risk appetites sharpen.

At other times, when investors rein in their risk-taking, the ratio tends to rise in favor of GDX.

Presently, the GDX multiple is 1.72x — not its lowest value, but well off its most recent top at 1.92x. If the ratio breaks through the 1.72x level, a test of its old low at 1.69x is likely to follow.

GDX/GDXJ Ratio

(Click to enlarge)

So here’s the deal: A falling ratio means a bigger market appetite for risk. More specifically, a bigger appetite for mining stock risk. That, in turn, is an expression of investor confidence in bullion’s price strength.

If you’re a bull, then, you want the ratio to fall.

We’ll keep you apprised of the ratio’s course in our Friday “Inflation Scorecard” columns going forward. That way, you can gauge your own bullishness against that of the market.

Disclosure: No positions