Is The Junior Mining Sector About To Implode?

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: http://themacrotourist.com/images/2017/04/AddsApr1917.png

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

Scotiabank estimates that the 23 new additions will ultimately constitute 63% of GDXJ.  http://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 $2.6 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 $320,000.  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.

58 Comments

brolgaboy's picture

First?

some really nasty stuff going on with Van Eck

Turd Ferguson's picture

My man Pining...

MODERATOR

...swings by on a Friday afternoon and unveils this terrific and comprehensive post. Thank you!

Pining 4 the Fjords's picture

My pleasure TF

I hope it sparks discussion, I will be truly interested in the opinions and counter-arguments. 

Have a great weekend, my friend!

Vydūnas's picture

Great analysis

This explains a lot - starting with February disconnect between the miners and the metals. And last days JNUG price action is clearly disconnected.  Thank you Pining!

Orange's picture

What a post Pining Thanks

Very well thought through and informative.

joja's picture

FFMGF

Is First Mining Finance Corp now an opportunity ?

Orange's picture

FFMGF

I don't think they are on the list but First Majestic is.

Mickey's picture

mass confusion but

if people want juniors, then they have to start doing homework and actually buy the juniors.

Let's not forget how much money has gone to teh sector.

nonetheless, the driving factor in the future wil be if more money especially new money comes into the sector.

near term I'd think gdx or nugt as money will flow to that subsector, lighten up maybe on gdxj and jnug, however, then what we have is gdx holding the biggies and GDXJ holding the rest of the miner universe. And thats not bad.

Consequently, how does this play out short term.

Bifurcated.

tthe juniors that have been identified as sales have already been hit so the question is how much more.

Remember last year when GDXJ took AG out of the fund . Had GDXJ known all this then, they would not have done this as they are adding AG back.

so I think short term we have winners and losers and then revert back to the mean.

On JNUG, I think it makes it easier and less expensive for JNUG to get swaps. The expanded JNUG universe will have more liquidity.

And it looks like silver miner holdings in gdxj will expand.

I guess we wil see.

how can we interpret this if GDXJ management is at a loss for ideas.

in the future-IF more money flows to teh mining sector, how wil that all be absorbed? Higher prices?

Actually hedge funds-the private equity guys have done this for year--they keep buying lesser quality companies so as to keep AUM. If they do not use cash on hand, they lose it. That is  also why brokers and RIA's will deploy cash nearly fully. That is part of reason why markets are staying high, and why RIAs do not want their clients buying physical.

perhaps this evening after a nap I wil be more coherent.

I almost bought calls on JNUG this afternoon thinking we see a strong rally sometime in next 60 days. Almost.

If Bo is correct it will not make a difference after next week. If.

addley1000's picture

Crowded Trade

I view the GDXJ as a very crowed trade. Just like the long dollar trade. With GDXJ so big ... who is left to toss in money? Junior gold investors are already there. 

Turd Ferguson's picture

I sent it over to Goldseek

MODERATOR

And they published it, too. Also, I bet The Doc will put this on his site over the weekend.

Response to: My pleasure TF
tonym9's picture

Pining nice to see it put in

Pining nice to see it put in such a concise article. This should get picked up by ZH or SA. Well done Sir. 

My only question, and it is the same question I've had since the announcement, is what does JDST do? I have not arrived at an answer myself and I doubt anyone can. But if one does recognize the opportunity within the question, it is a worthy discussion. 

I know most stackers have an inherent dislike of the pm x3s, especially the bear x3s. Accepted and understood.

All should consider:

1. Does the above scenario sound plausible?

2. If plausible, do you sell your jr miner shares? 

3. If plausible, does JDST do what it is supposed to do when the juniors get hammered?

The potential opportunity to get a large percentage move in JDST exists. In a short amount of time. One can also lose a hand...

Mickey's picture

perspective

last spring was up 1700%-NUGT was only up around 1000%

GDXJ was up a little over 300%, GDX was up 253%

meld them together for a overall mix and you do ok

or just go out and buy options on individual stocks-which I still do

its more work and attention , but I think the rewards are good also.

and timing on both strategies similar.

look at rally in metals at end of day

the markets are phony anyway so what's the big deal?

the economy is shot so whats the big deal

we all here want to be in metals and JNUG should only be a relatively small part of your portfolio anyway.

having said that I always look to get a leg up. I think juniors, or some of them, wil be a heck of a buy if not already.

petedivine's picture

Dave from Denver

Dave Kranzler puts out the investment research Journal and he opines on JNUG as well. He seems to have reached a different conclusion then the one from Pining for the Fjords . I would love to see Dave Kranzler share his opinion in an interview here on  Turdville. It would be great to see another perspective. Hopefully, one as well reasoned as the excellent contribution from Pining of the Fjords.

OOOBuck's picture

So.... GXDJ is screwed regardless of new mix

and so are all the Jr. miners.   Have I got about right?

Billygoatsgruff's picture

Comment from Direxion

I emailed Direxion the other day asking for explanation of discordance between JNUG and GDXJ. Here's what they responded with...

Jordan-

Thank you for reaching out to Direxion. Both JNUG and JDST have daily investment objectives to return 300% and -300% of the daily return of the MVIS Junior Gold Miners Index. On a daily basis, the change in net asset value for JNUG and JDST will reflect 3x and -3x the percentage move of this index. For any leveraged and inverse ETF with a daily investment objective, exposure is rebalanced each day and performance over longer periods of time will not necessarily reflect 3x (or -3x) the return of the index due to compounding of returns. Over time, volatility in an index creates negative compounding in a leveraged product which leads to decay; there has been significant volatility in this index over the time periods you mentioned, which explains the difference you pointed out. On the other hand, leveraged and inverse ETFs benefit from periods of low volatility and trending markets, as evidenced by the returns of JNUG and JDST in the first 2 quarters of 2016 when volatility was low and that index was trending. I have included 2 PDFs; one explains the performance of a leveraged ETF over time and the other specifically discusses the impact of volatility. Please review and let me know if you have any further questions.

Best,

Brendan

Brendan Cavanaugh

Senior Vice President

Institutional ETF Strategist

Here is a link to the documents sent over...

https://drive.google.com/open?id=0B6A8fFvoFKsCWUNBQnVlWDNQaWc

OOOBuck's picture

Sorry, that's GDXJ (sp) and

I have backed out of a few of the miners on the GDXJ delete list.... but not all.  I think Pining is suggesting that it doesn't have to be on the list, that really, the entire sector is going to get creamed.   I've got to let this spin out a little bit before simply selling everything.

argentus maximus's picture

Thanks Pining. Your thoughts

Thanks Pining.

Your thoughts are much appreciated!

billhilly's picture

Close of business numbers...

ETF                    CLOSE  4/13 (TH)              CLOSE 4/21 (FR)            PCT CHANGE

GDX                              24.54                                   23.61                                  -  3.8 %

NUGT                            11.15                                     9.87                                   -  11.5 %

------------------

GDXJ                            36.70                                   34.54                                  -  5.9  %

JNUG                             6.80                                      5.61                                  -  17.5  %

-----------------

HUI                               212.96                                205.55                                 -  3.5  %

------------------

Off the cuff interpretation...the JNUG caught down to the GDXJ today, hence its bias negative number on the day.  Still, for the week, the JNUG and GDXJ complex did adhere to it's 3X basis interaction (watching today's numbers alone would have been cause for concern that they had disconnected).

The GDX and NUGT complex also maintained its 3X relationship but faired far better on the week overall than the Juniors.

HUI was basically in-line with GDX.

brolgaboy's picture

Van Eck

I have gone through literally dozens of junior miners shareholdings today and VE has millions and millions of shares of almost all of them. Orca (Lundin) is the one exception that comes to mind. Also almost all had additions in Feb coinciding with a huge bump (Silvercorp as an example). I have just one question for anyone that cares to reply?? Who the hell were they buying from?

Boggs's picture

I'm a CPA and I can't figure

I'm a CPA and I can't figure out what the hell you people are talking about...y'all are much smarter than me, I'll stack.  I do understand how that works.

jcm's picture

Maybe

Thanks Pining for your analysis. However, I don't think its necessary to be an optimist to take the opposing point of view. The GDXJ rebalancing clearly was noticed by the market; I don't think you can say its flown under the radar. As soon as the news was out, market participants positioned themselves to profit from the rebalance by shorting the underlying constituents whose allocations will be reduced. At this point, everyone is on the same side of the boat, and just like every other time this happens, the market will go the other way.

I think it will be more interesting to see how the majors react to this temporary repricing of the juniors. Will they step up M&A and acquire quality assets on the cheap? This in turn would trigger short covering by the targeted junior and could spread to the other juniors as market participants realize that their short may be an M&A target as well. 

I don't think its as clear cut as you propose.

104365's picture

JNUG/JDST

As I mentioned last week, I kept a lot of my JNUG shares, went to cash onthe rest, and hedge them with JDST.  The divergence from JNUG and JDST allowed me to stay green. 

Very weird.  I still have faith in JUNG.  It will be bumpy but when/if we get a black swan it'll start moving and everyone will jump on the bandwaggon.  Although, it may start to right from sub $4.00 level. 

BillD's picture

April 23/24 AGAIN

https://www.thesun.co.uk/tech/3379806/solar-flare-spewing-from-mega-hole-in-the-sun-could-cause-blackout-mayhem-next-week/

olar Dynamics Observatory recorded the massive coronal hole on April 21

This coronal hole is a vast region where the Sun’s magnetic field tears apart, allowing solar wind to escape.

Super-charged solar winds flowing from the Sun’s atmosphere are expected to reach Earth on April 23 or 24.

According to the US National Oceanic and Atmospheric Administration, this could whip up a “moderately strong” geomagnetic storm.

EDIT;  WONDER if this could be connected to the NYC "nuclear" alert "test" April 21/23/24 ... ??   Get prepared for chaos?  lol
 

Pining 4 the Fjords's picture

@jcm

You wrote "Will they step up M&A and acquire quality assets on the cheap? This in turn would trigger short covering by the targeted junior and could spread to the other juniors as market participants realize that their short may be an M&A target as well."

This is a very interesting thesis, good thinking! It would need, first, to have at least some of the stuff I talk about here to play out to some degree, but you are identifying a great tipping point where the process would stop. Really good thing to consider... 

104365's picture

Pining 4 the Fjords

Thank you so much for your perspective.  This is why I love this site.  Just amazing members and contributors. 

Doople's picture

Thank You Pining

Nice job of defining the problem and then explaining it for some of slower members of the blog like myself.

matt_'s picture

I've become a dot chaser...

I agree with Mickey (and also with Eric Sprott's commentary TF posted earlier) : if you want "outsized" returns from the junior miners, you really need to do your research and buy shares in the individual companies.  You would think that all the interest in the GDXJ would push the individual company shares higher, but it doesn't look like things will work out that way in the short term.  I've spent years reading company reports and corporate presentations, reading articles and commentary on companies, etc.  I'm not good at it and I'm not doing it any more.

For me, I've decided to become a dot chaser and forget about researching mining companies.  I actually sold a lot of my mining shares today to generate more cash for trading.  The more trading I do, the more confident I am that I can significantly lower the volatility of my portfolio and still make appreciable returns in a variety of market conditions.  All my back testing and trading experience so far shows that it beats the hell out of the roller coaster ride I have been on.

Dr Jerome's picture

RIP JNUG

Well, that is the message the markets are sending me.

But if JNUG survives, it may be a good buy in that sub-4$ range.

Pining, I appreciate that you pointed out the possibility of junior miners being hammered in the near-term and becoming a good buy at lower prices due to the shifts in the behemoth ETF instruments. 

I was tempted to buy into something that is "long gold" today, but then I considered that TPTB want to keep gold below that 5-year trend line. I'll stay on the side and watch... perhaps for a long time. I still have not found a replacement for JNUG in my limited 403b portfolio options.

Anyone have experience with UGLD?

el_duderino7885's picture

GDX??

Does this mean the GDX is safe for now?

if so wouldn't there be a rush of GDXJ investors moving in to the GDX?

djr66's picture

My Theory...

I think you may be overestimating the impact of this rebalance on the total demand for junior mining shares.  People invested in GDXJ because they wanted exposure to this sector which is highly leveraged to the Price of Gold.  If they cannot get this exposure no longer from GDXJ, they will look for alternatives.  Smaller pure play funds will likely see a significant increase in inflows.  But I think when it comes to instutional money this may largely be a wash.  Let me explain.

My theory is that say you are an institution and you hold $1 Million in GDX and $1 Million in GDXJ.  You will still want to have the same exposure to the junior miners after the rebalance as you did before for diversification purposes.  So the solution would be to sell maybe half of your GDX and put that money into GDXJ.  At the end of the day it would give you roughly the same exposure to the underlying components as you had before.  Therefore I wouldn't be surprised if GDXJ gets a significant increase in AUM at the expense of GDX. 

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