Why Gold Shares in the GDXJ EFT Could Skyrocket

Source: John Newell 09/26/2024

John Newell of John Newell & Associates explains why he believes the current gap between GDXJ and the price of gold presents a rare opportunity for investors.

In the world of precious metals investing, it’s rare to see gold shares lagging significantly behind the price of gold itself. Yet, today, we’re witnessing one of the widest gaps between the VanEck Junior Gold Miner ETF (GDXJ:NYSEArca) and gold prices in history.

Typically, gold shares trade at a premium relative to gold because of the leverage effect on gold company earnings, but the market has become increasingly disconnected.

This discrepancy offers investors an incredible opportunity, as gold companies are making substantial profits even at relatively flat gold prices.

Let’s dive into the chart of GDXJ relative to gold and examine why this gap exists, what it signals for the future, and why gold shares could soon outperform gold itself by a wide margin.

The GDXJ-Gold Price Disparity: A Visual Overview

Looking at the GDXJ ETF’s performance against gold reveals a significant divergence. While gold prices have surged to above $2600 in some markets, the GDXJ index has not mirrored this growth. Historically, gold shares have traded at a premium to the underlying commodity due to the leverage they offer on earnings. When gold rises, gold mining companies see greater profitability, especially those with lower average all-in sustaining costs (AISC).

A typical junior gold miner in the GDXJ ETF might have an AISC of $1400 per ounce. With gold trading at $2600, the margins on each ounce of gold produced are substantial. However, despite this, GDXJ shares have remained underpriced, widening the gap.

Leverage Effect: More Than Just Mining Costs

One of the primary reasons gold shares tend to outperform physical gold is the leverage effect on company earnings. When the price of gold rises, a miner’s profit margins expand exponentially. Lower-grade ore that was previously too expensive to mine becomes economically viable, which adds to reserves and improves the company’s valuation.

The leverage effect also attracts investors like pension funds, hedge funds, and institutional buyers who tend to underweight gold shares. These funds can’t ignore the sector forever, especially as profit margins expand, balance sheets improve, and the miners begin to report windfall profits.

All-In Sustaining Costs and Profitability

One of the key drivers behind this phenomenon is the AISC, which represents the total cost of mining an ounce of gold, including operational costs, sustaining capital, and overhead. Many gold miners in the GDXJ ETF have AISC figures around $1400 per ounce. With gold trading at $2600 or more, the profit margins on each ounce of gold produced are enormous, far exceeding those of most other sectors.

The current gold price offers a buffer, meaning even if the price remains flat for a while, gold companies will still be making significant profits. This kind of steady earnings growth, paired with widening margins, is likely to attract more investment into gold shares, driving up their value.

Gold Shares are Historically Cheap

Despite the healthy profit margins and leverage to rising gold prices, gold shares have remained cheap. A key reason for this could be investor sentiment. Investors have been slow to reenter the gold mining sector due to market volatility, macroeconomic uncertainties, and underperformance in previous years. However, with rising gold prices and positive earnings reports from miners, this sentiment is beginning to shift.

The underinvestment in the sector, especially from large institutional investors, is creating a scenario where gold shares are still undervalued relative to the fundamentals. As gold prices stabilize or rise further, more capital will likely flow into gold equities, closing the gap between GDXJ and gold prices.

The Potential for Gold Shares to Outperform

While gold prices may stabilize at these higher levels, the potential for gold shares to outperform is significant. Even if gold remains relatively flat, the profit margins for gold miners continue to expand. As a result, the financial health of these companies improves, and their share prices should rise as investors recognize the value.

This leverage effect can drive share prices higher even without a massive move in the price of gold. Moreover, as exploration companies in the GDXJ index continue to discover new deposits and expand their resources, the upside potential grows.

Conclusion: A Once-in-a-Decade Opportunity

The current gap between GDXJ and the price of gold presents a rare opportunity for investors. With gold prices at or near all-time highs, gold shares in the GDXJ ETF are still trading at levels that suggest they are significantly undervalued. The combination of wide profit margins, leverage on earnings, and the eventual influx of institutional investment makes gold shares an attractive investment.

If history repeats, this gap will not remain for long. The fundamentals are solid, and even a flat gold price could result in substantial gains for gold shares. As the gold mining sector becomes impossible to ignore, investors who move early stand to benefit from what could be one of the best buying opportunities in years.

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John Newell Disclaimer

As always it is important to note that investing in precious metals like silver carries risks, and market conditions can change violently with shock and awe tactics, that we have seen over the past 20 years. Before making any investment decisions, it’s advisable consult with a financial advisor if needed. Also the practice of conducting thorough research and to consider your investment goals and risk tolerance.

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