Anthony Bradshaw
Introduction
Investors in the VanEck Gold Miners ETF (NYSEARCA:GDX) have been rewarded as the gold price (GLD) recently hit record highs, with shares in GDX now up 24% since the beginning of the year. With geopolitical tensions rising and strong central bank buying, I believe the price of gold has potential to increase further. The potential for falling interest rates adds to this favourable outlook, with reduced rates making gold more attractive compared to alternative assets. This rising gold price offers a potential boost to gold miners, enhancing their profitability, making GDX an interesting prospect for investors seeking to profit from the rising gold price.
Within this article, I would like to explore in more detail the drivers in the gold price, why I believe this is not just a short-term rise, and how gold miners stand to benefit. Without delay, let’s explore why I think the VanEck Gold Miners ETF is a buy.
A Rising Gold Price
The recent rise in the gold price has been remarkable, recently hitting record highs of over $2500 an ounce, up over 21% since the start of the year and even outperforming the S&P 500 which is only up just over 15%. So, what’s leading to this surge in the gold price. This can be put down to several factors, factors that, I believe, will continue over the coming years, making a strong case for further increases in the gold price.
A key catalyst behind the recent price rises has been increased gold buying by central banks. Central banks, particularly those in emerging markets, have increased their gold purchases to help diversify their reserves and reduce their reliance on the US dollar. According to the World Gold Council, central banks bought 483 tonnes of gold in the first half of this year, a record amount. This surge can be partly attributed to geopolitical tensions. Following the start of the conflict in Ukraine, Russian assets were sanctioned, resulting in the freezing of Russian foreign reserves. This freezing of foreign reserves has sent a powerful message: holding dollar-denominated reserves can be risky. Who would want to if it meant your assets could be seized at any time. This, predictably, led to a shift away from the dollar towards gold and making a country’s reserves more independent of the Western financial system.
World Gold Council Central Bank Gold Statistics July 2024
This growth in central banks gold buying does not look set to stop, with 69% of central banks expecting gold reserves to be higher in the next 5 years, compared to only 13% who believe it will be lower. This looks like to be a strong source of demand heading into the future, helping support a higher gold price.
2024 Central Bank Gold Reserves Survey
With 110 conflicts currently ongoing around the world, these are unstable times. With tensions rising in the Middle East, conflict in Europe, and growing concerns surrounding US-China relations, investors are increasingly seeking out safer assets to hold. Gold fits the bill perfectly having been traditionally seen as a safe-haven asset and a store of value. Viewed as a hedge against geopolitical risk and economic downturns, its price stands to benefit from this uncertainty and instability.
Another key factor at play is the outlook for interest rates. Gold is a non-yielding asset. It does not produce any cash flow or pay out dividends. In a higher interest rate environment such as that of the past few years, this results in a higher carrying cost for gold. With some central banks already cutting interest rates and the Fed looking set to begin cutting soon, this boosts the appeal of gold by reducing the carrying cost, acting as a greater incentive to hold it. Falling interest rates could also weaken the US dollar, and gold, as a dollar-priced commodity, would be cheaper to foreign buyers helping drive demand.
These three main factors; central bank buying, geopolitical tensions, and falling interest rates, appear to be creating the perfect environment for a sustained rally in the gold price. Although gold has risen to a record high already, for the reasons discussed above, I believe it has the potential to go even higher. So how should investors play the rising gold price.
Understanding GDX
The VanEck Gold Miners ETF, trading as GDX, is an ETF that aims to offer investors exposure to a selected basket of large gold mining companies by replicating the NYSE Arca Gold Miners Index. As such, it offers indirect exposure to the price of gold as the performance of gold miners is closely tied to changes in the gold market. It is a market cap weighted ETF, meaning smaller companies are excluded, and includes both gold miners and gold royalty companies.
I prefer investing in miners over the underlying commodity due to the ability of miners ability to generate vastly greater profits, margins, and returns as the price of gold goes up, as it has recently and as I believe it will in the future. Additionally, it allows exposure to new mines as they come online.
Currently. the top 10 holdings of the ETF are Newmont (NEM), Agnico Eagle Mines (AEM), Barrick Gold (GOLD), Wheaton Precious Metals (WPM), Franco-Nevada (FNV), AngloGold Ashanti (AU), Gold Fields (GFI), Northern Star Resources (OTCPK:NESRF), Zijin Mining Group (OTCPK:ZIJMF), and Kinross Gold (KGC). There are a total of 54 holdings, with the top 10 holdings representing 66% of assets. Although some of these miners engage in mining not just gold but other commodities, all their gold mining operations are of significant size such that they are significantly exposed to the price of gold. By investing in a diversified ETF, it allows for global exposure across multiple mines and at a reduced risk through diversification, helping to mitigate the impact if a particular company runs into problems.
As discussed earlier, I am bullish on gold in the long term and believe investing in gold miners is a great idea in a rising gold price environment. By investing in GDX, it allows exposure to the price of gold through a diversified portfolio of companies that are all involved in gold mining. Therefore, I rate GDX a buy for the long term.
Risks
Investing in GDX and gold mining in general is not without its risks. There are three main risks I believe it is important to consider. The reliance of earnings on the price of gold, problematic mergers, and rising costs.
Firstly, the price of gold. Gold miners are heavily exposed to the price of gold and are price takers. When gold prices rise, miners see significant profit increases due to operational leverage, however, the opposite is true if the gold price declines. This reliance on gold prices means GDX’s performance is directly tied to that of the gold market. Although I am bullish on the price of gold in the longer term, the potential for reductions in the gold price and hence the shares of gold miners cannot be overlooked.
Secondly, problematic mergers and over optimistic assumptions. There is a stereotype about the gold mining industry being overly optimistic, leading to a history of costly mergers and acquisitions, and expansion projects. This stereotype isn’t unfounded, between 2011-15 gold miners took an estimated $80 billion in impairments on mergers they overpaid for and on projects that faced significant cost overruns. These mistakes cost shareholders as they result in poor returns and reduced confidence in management. While there appears to have been some improvement in capital discipline in recent years, this risk remains, though GDX reduces this risk by being exposed to a diversified range of miners, so problems at a single miner can be mitigated.
Finally, rising operational costs. Gold mining is clearly not free and is subject to many cost pressures. Over the years ore grades have continued to fall, requiring more material to be extracted for the same amount of gold, increasing costs. Additionally, the industry faces rising costs from higher oil prices, wage inflation, and tightening regulations. These factors can erode profit margins even if gold prices remain stable or rise slightly. With increased environmental and regulatory scrutiny, and stricter standards on mining operations, costs are rising, and opening or expanding mines is becoming more difficult.
Conclusion
A key advantage of holding miners over the underlying commodity is that increases in the commodity price can amplify a miner’s earnings due to operational leverage. With the gold price recently hitting a record high, profits for gold miners should increase. With multiple factors underlying the recent gold price rise, I believe the price of gold is merely heading up. By investing in a diversified array of gold mining companies, this ETF gives investors exposure to the potential growth and opportunities in the sector, as well as to the gold price that drives many miner’s share prices, whilst mitigating the risk of investing in a single company. I therefore give the VanEck Gold Miners ETF a buy rating.