Is The Junior Mining Sector About To Implode?

58
Fri, Apr 21, 2017 - 2:43pm

Understand this is just one trading and investing Parrot’s opinion, but I have read numerous interpretations/spins/takes on the GDXJ rebalancing, the JNUG implications, and none of them have seemed to me to honestly get to the core issues or implications of this major event as regards the immediate future of the junior mining sector (and possibly the entire sector as a whole, in the short-term). So in this piece I thought I would lay out, part by part and fact by fact, what I think might be implications that nobody is really talking about, either because they have vested interests in the sector and are afraid of spooking investors, or because they simply haven’t thought through the implications or imagined what may happen if the dominoes fall. Understand that this is speculative, but also understand that to dismiss this thesis, you must factually explain why the ‘cause and effect’ I am about to lay out will not take place. It is not my intention to discourage or frighten people, simply to warn them of a possibility that seems to me to be entirely realistic based on current fact and evidence. If I am wrong or in error, I gratefully welcome different interpretations of the data- the entire point of this is for all of us to do well in the end!

The Summary Case in a Nutshell:

  1. GDXJ, which already is 5% GDX (not juniors) and contains other significant holdings that are not really juniors as well, has now announced a rebalancing June 17th whereby they will be selling a long list of smaller junior miners (and not buying more) and adding larger-cap companies to their index. In short, this “junior mining” ETF is becoming essentially “10% large miners, 50% mid-cap producers, 40% larger juniors” ETF. The juice that used to be provided by the smaller miners is now either gone or at least largely diluted.
  2. This announcement will hit a big list of small mining companies in two ways. First is the obvious disgorging of GDXJ shares (representing 2.6 billion dollars of selling, or about 6-8 trading days-worth of share volume per company, all selling that has to be absorbed the market). The second, however, is the double-whammy this has on each of these companies in that (a) individual investors are/will sell their shares in anticipation of this, and (b) it will discourage future investment in these companies since everyone knows you cannot count on that big flow of GDXJ money ever coming back in to these stocks. This will depress the entire sector as a whole to some degree. Say goodbye to that easy pension, casual investor, and 401k money. From now on, those companies are niche investor targets only. Bad sign.
  3. JNUG, the 3x ETF based on GDXJ, has been the “risky bet” trading vehicle of choice for traders who want high risk/high reward exposure to gold, so much so that JNUG is now a 1.2 billion dollar behemoth. JNUG, however, leaks value vs the underlying GDXJ over time and this is reflected by a forthcoming 1 for 4 reverse split in the shares. It is feared that this split may signal even more leakage, putting traders on edge.
  4. The GDXJ rebalancing away from the juniors means that going forward, JNUG will not offer anywhere near the “juice” to traders it once did in terms of 3x exposure to the potentially fast-moving small junior stocks. Without this additional pop, why trade or hold JNUG? Why be in this leaky vehicle where the underlying GDXJ has torpedoed its underlying portfolio by (a) announcing its sales ahead of time and (b) essentially moving away from the very thing (exposure to the potentially high-flying small companies) that once made it attractive? These things will likely cause traders to move away from an increasingly sluggish JNUG.
  5. If traders leave JNUG, it will be devastating to GDXJ- the swaps and futures that allow JNUG to function represent roughly HALF the market cap of the 5.3 billion dollar GDXJ. If traders decide JNUG is no longer the rocketship it once was and hence is not worth the trouble, and just 20% quit trading JNUG, this is the equivalent of half a billion dollars fleeing GDXJ… if 40% quit trading JNUG, it’s the equivalent of a billion dollars exiting GDXJ. These types of outflows, in a short period of time, could mean serious price carnage in such a small sector.
  6. The thesis of this piece is that this chain of developments has the potential to devastate the junior miners in the short run, coming on top of the effects of the GDXJ rebalancing.

What did they know, and when did they know it?

This decision didn’t happen overnight. The folks who run GDXJ had to have made this choice, and understood the potentially deadly ramifications for the entire sector, quite some time ago. I think I know when.

Back in February I saw something in the charts that truly baffled me, a disconnect of a magnitude that I haven’t seen in 15 years of pouring over gold, silver, and mining charts on a near daily basis. There was a startlingly odd disconnect between the miners and the metals, when from Feb 10- Feb 26 Gold was up 3.6% yet the juniors were down 8%!!!

This bizarre, counterintuitive move was capped off by the big smash in miners on Monday, Feb 27 when GDXJ was hit for an additional 11% in a single day. When gold is flat over ten trading days, yet the juniors and down a whopping 20% over that same time on no news, something is definitely up. What is interesting is a tidbit our fellow Turdite Murphy sent me. In the final 15 minutes of trading that day of the big drop, Monday Feb 27, 775 million dollars of GDXJ shares changed hands... That is equivalent to the entire average daily volume of shares traded in that ETF in just the final 15 minutes of trading. On “no news”.

This is pure speculation, but I think this time period is when this decision was made- in a rising gold market, the juniors fell by 8% and ultimately 20% for no particularly good reason known publicly. This is when big money got out, and left us holding the bag. Sorry, but we are the last to know and that’s how it works.

The rebalanced GDXLCMCPBSM: The GDX Large Cap+ Mid-Cap Producers+ Bigger Small Miners fund

GDXJ already holds GDX. Everyone has seen the new rebalancing lists by now, but if you haven’t, here are the links.

The GDXJ adds: https://themacrotourist.com/images/2017/04/AddsApr1917.png

The GDXJ drops: https://themacrotourist.com/images/2017/04/DeletesApr1917.png

Scotiabank estimates that the 23 new additions will ultimately constitute 63% of GDXJ. https://www.nasdaq.com/article/gold-miner-etf-gdxj-to-undergo-dramatic-change-cm775363#ixzz4euPdSaWl

From the above article, here is the quote that should send chills through every owner of a small mining stock: “The fund will see dramatic offloading of current index components to fund the new additions. Scotiabank estimates that the fund could have to sell .6 billion of fund assets, representing approximately 2.5-8% of each individual existing component.” How is a market as small as the juniors supposed to absorb 2.6 billion in selling without major price disruptions? I think this explains the February sell-off… inside money knew this was coming, and already sold.

Let’s be honest: JNUG is a gambler’s ETF

The reason JNUG has grown into a billion dollar ETF is simple- greedy people like me (and you) look at last Spring’s rise and start doing the math, and say “If gold went from 1048 to 1375, I could have bought GLD and made 30%... but JNUG went from 2 bucks to 32”. We start thinking that we can invest 20k and turn the next rip in gold into a 16 bagger in 4 months, and turn that 20k into 0,000. Honestly, we should admit that is the only reason people buy JNUG, and put up with the decay vs. the underlying over time. With the new changes to GDXJ that simply isn’t going to happen anymore. And when people realize this, it will be a problem. Maybe a billion dollar problem.

Scotiabank also estimated that as much as 50% of the 5.3 billion market cap of GDXJ is due to JNUG, and the complex strata of swaps and futures needed to get that 3x leverage to work. If people leave JNUG because GDXJ has turned itself into a boring, vanilla mid-cap fund, and because they cannot in any way reasonably believe they can replicate that stirring 16 bagger we saw last year, then GDXJ could be in deep trouble. If just 20% of “investors” (gamblers) quit JNUG that is a half-billion dollar outflow from GDXJ, at least. If 50% leave it could reasonably be a 1.1 billion outflow from the junior mining sector… and that is ON TOP of the already massive 2.6 billion dollar outflow from the companies on the GDJX “cut list” mentioned above. You see the potential for carnage yet? This just isn’t a big enough sector. In a period of a month or two it simply cannot absorb such outflows without massive price disruptions.

Proof of Concept?

One of these things is not like the others…

Gee, it's almost as if, sometime around April 11-12, something happened that disconnected JNUG (or more specifically, the underlying GDXJ) from the normal flow of market forces affecting the other 3x instruments- something that was truly specific to that instrument, and made it deeply undesirable to investors, who started to flee it in droves....

In addition, JNUG and JDST should mirror each other. Instead, they have started to diverge, by a whopping 5% as of Thursday:

Since the infamous April 11-12 GDXJ rebalancing announcement, coming on top of the looming 1 for 4 reverse split already announced for JNUG, the gap between JNUG and it's supposed opposite JDST continues to widen. As of price at the time of my posting this, in just the last five days the difference between the two has grown to 5.28% in just five trading days!!! Note that during that same time, NUGT and DUST are holding their normal inverse relationship quite closely as they should, so it is just these two... all while gold (even expressed in UGLD) is basically flat. People leaving the miners, and FLEEING the juniors:

When Van Eck announced JNUG "suspension of issuance of new shares" and they added that it might mean that it will trade "at a premium to NAV", I posted here at the time that they did this to try and hold the short sellers at bay if they could, and to stem or somewhat manage the carnage they saw coming. The premium to NAV bit was just misdirection to pretty it up. This attempt to artificially prop up JNUG likely accounts for the 5% + difference between JNUG and JDST...

So without the prop of not issuing new shares, only buying back - thus shrinking supply somewhat (which they can only do with cash on hand, till it runs out) then JNUG would be knocking on the door of a 25% drop... Think about that, if JNUG "should have dropped" 23.28% commensurate with JDST's rise, and JNUG swaps and futures represents 50% of the market capitalization of GDXJ, which is 5.3 billion, that is roughly 600 million dollars of market cap flowing out of the junior miners in just the last five days. It hasn't worked it's way through the system yet to truly move price since these are swaps and futures, but it may soon...

Is there a silver (and gold) lining?

Well, if you are a complete optimist you could argue that between the 20% Feb/March drop prior to this becoming public knowledge, and the time since then which has included the above drops in JNUG and GDXJ, that much of this may already be largely priced in. Obviously, I don’t think so, and I believe the effects of the JNUG exodus are yet to be fully felt, but one could make the case that (a) that is overblown and JNUG will keep on trucking because traders don’t care and want their juice, and (b) the GDXJ hit is already largely behind us. So if you are of this mindset, perhaps this is the BTFD moment. Personally, this parrot is not counting on that. Time to batten down the hatches, mateys.

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tommy
Apr 23, 2017 - 5:38pm

Info, great job, thanks!!

That would be my opinion as well, but hey, once you ascribe to the 'ball kept underwater' paradigm you always see room for improvement. I think this article also nails it, already posted by silverwhere:

https://themacrotourist.com/macro/the-real-message-from-the-gdxj-mess

Anyway, great article by Pining and great responses by the rest, really enjoyed it...

infometron
Apr 23, 2017 - 5:24pm

@tommy

I concur on all counts, Q1 results should reflect significant increased profits for junior producers, given their leverage to the spot prices of the metals over that period of time.

The way things are shaping up, it may well be the last best opportunity to by the dip.

tommy
Apr 23, 2017 - 5:13pm

info

I love this community. Looking at this performance it seems these juniors have already absorbed the bulk of the impact, also because these fraudsters have probably created a big amount of naked shorts. Anyway, the news is out, let's see how these juniors react to first quarter results. Investing in the precious metals space? Never a dull moment:)

p.s. I don't think I'll sell any of the 'divestments' nor buy any of the additions. If we see one more dip in the 'divestments' I think I'll add those though. call me old fashioned, but I like fundamentals

silverwhere
Apr 23, 2017 - 4:14pm

Van Eck announcement

A DISCUSSION OF THE INDEX RULE CHANGE FOR MVIS GLOBAL JUNIOR GOLD MINERS INDEX

NEW YORK (April 21, 2017)

On April 12, 2017, MV Index Solutions GmbH (MVIS) announced changes to the rules for several of its equity indexes to be effective June 17, 2017. In particular, with regards to the MVIS Global Junior Gold Miners Index (MVGDXJ), MVIS has expanded the universe of companies eligible for inclusion in the index.

Potential Impact of the Index Rule Change ...

https://www.vaneck.com/miscellaneous/mvgdxj-index-rule-change.pdf

silverwhere
Apr 23, 2017 - 3:23pm

GDXJ - must read?

In what seems a lifetime ago, I was the equity index trader at a big bank on Bay Street. Although a lot has changed since then, there are parts of the game that are timeless. So I am putting my old hat back on to analyze VanEck’s recent problems arising from the success of their GDXJ ETF (Junior Gold Miners). And lest you think this will be a boring ETF specific piece, I urge you to suffer through the details as I believe the market is missing the bigger picture message.

...

On Thursday, MVIS Index Solutions, a VanEck company, announced changes to its equity indexes, widening the criteria for inclusion into the gauge that is tracked by VanEck’s junior gold miner ETF.

...

The Real Message from the GDXJ Mess

by Kevin Muir 19 Apr 2017

https://themacrotourist.com/macro/the-real-message-from-the-gdxj-mess

Markedtofuture
Apr 23, 2017 - 2:41pm

Stateside Report Podcast – April 23, 2017

In this week’s episode of the Stateside Report Podcast we take a look back at the week in gold, silver, the base metals and the stocks, We talk about the upcoming GDXJ re-balancing and finally we talk about the key press releases from the week in the Canadian junior exploration sector including Barkerville Gold Mines BGM, Camino Minerals COR, Canadian Orebodies CORE, Volcanic Gold Mines VG, Spearmint Resources SRJ, Adamera Minerals ADZ, Alto Ventures ATV, Arizona Silver Exploration AZS, Evrim Resources EVM, Alset Energy ION, GT Cold Corp GTT, Kootenay Zink ZNK, Pasinex Resources PSE, Metalore Resources MET. We talk gold, silver, lead, zinc, copper, uranium, natural gas, oil and CEO.CA

https://statesidereport.com/

lakedweller2
Apr 23, 2017 - 10:24am

Is The Conclusion

That it appears that the GDXJ rebalancing was known in advance by the professional investment community, the trades front run in advance of public knowledge or announcement, and the last 2-3 months they have been milking the trades so they can maximize low prices, screw the public investors, insure better long term profits...all sanctioned by tbe Federal Regulators and Congress, during a period of crisis management and budget failure.

If so, does that negate current action for longs, but opens the door for new buyers, like Congress, who are legally allowed to trade on inside information and the bankers can because of no regulation. Is the horse out of the barn AGAIN, before the Public can act.

adonisdemilo
Apr 23, 2017 - 8:21am

@ Mickey97. I also hold a few

@ Mickey97.

I also hold a few of those same stocks.

These have been bought from about mid 2015 through to December last year.

Eg. FR @ GBP 3.527 NOW £ 6.84

FVI @ GBP 2.53 NOW £ 3.89

GPR @ GBP .438 NOW £ 1.04

AXR @GBP .2657 NOW £1.185

KL @ GBP 3.1975 NOW £5.79

SBB @ GBP .222 NOW £1.00

SSO @GBP 3.009 NOW £8.32

There are others, but my point is; WHY SELL ANY ?

I'M CERTAINLY ARE NOT GOING TO GET THE CHANCE TO BUY THEM BACK ANY CHEAPER, THEY ARE THER FOR THE LONG RUN.

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infometron
Apr 23, 2017 - 12:14am

Shout out to Dr P

Thanks, Pining... and a shout out to our local cynic, er, lurker, Dr P. If ever there was a metals and mining related topic for you to chime in on, this would be it!

Apr 22, 2017 - 11:57pm

Holy cow, that is excellent work

Thank you for the effort and for crunching those numbers and posting in this thread - it's great to save that for posterity, especially if we look back on this in a month or two to see how it all played out.

IF this GDXJ rebalancing was being front-run at that time in Feb when the decision was made, let's do some math on it. According to the Scotiabank analysts quoted in the article in my post, the swaps and futures needed for the JNUG architecture represents about 50% (they said 53%) of the 5.3 billion GDXJ. So that drop in JNUG you mentioned during those 4 days alone was 880 million dollars flowing out of GDXJ. More later on. Somebody was on the right side of all those trades, which happened while gold was RISING.

Nice work if you can get it...

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