The VanEck Vectors Gold Miners (GDX) exchange traded fund (ETF) is the most liquid vehicle for investors and traders to gain exposure to gold mining companies. The ETF was established in 2006 by VanEck in the midst of gold's bull market as securities were created to satiate the appetite of precious metals investors.

Since its inception, in May 2006, GDX is down 19.5% as of May 2020. Gold is up 98.5% over the same time period. This is unusual, given that the revenues and earnings of gold mining companies are tied to gold prices. However, the divergence is due to gold mining companies cutting production just as prices rose and expanding operations just as gold prices peaked. This mismanagement has led to frustration for many gold miner bulls.

Composition

GDX tracks the performance of the New York Stock Exchange (NYSE) ARCA Gold Miners Index. Its holdings include most major gold miners listed in the United States and Canada. Some of the largest holdings of the ETF are Barrick Gold (ABX), Newmont (NEM), Franco-Nevada Corporation (FNV), Newcrest Mining (NCM), Wheaton Precious Metals (WPM), and Agnico Eagle Mines (AEM). The index is market cap-weighted, meaning that larger companies are given more representation.

Characteristics

GDX is managed by VanEck, which makes adjustments to holdings based on changes in the NYSE ARCA Gold Miners Index. GDX sports a very low expense ratio of 0.52%. Additionally, the stock trades on the New York Stock Exchange. In recent years, public interest has spiked in gold and gold miners due to concerns surrounding monetary policy. Commensurate with this increased interest, volume has steadily climbed higher.

Suitability and Recommendation

GDX is particularly risky. Investors have to be mindful of gold prices as well as the mining industry. As its lifetime performance shows, a rising gold price does not necessarily mean that GDX will also rise. However, a falling gold price certainly ensures a decline in GDX. However, in the right environment, GDX can deliver spectacular returns for investors. From October 2008 to May 2011, GDX rose nearly 300% as gold climbed 150% over the same time period.

For these reasons, GDX is considered speculative and is appropriate for sophisticated investors who are comfortable with the risk. The ultimate driver of GDX's price is earnings from gold mining companies. In the short term, the largest variable affecting earnings is the price of gold. Determining the price of gold is notoriously difficult due to its lack of cash flow and emotionally driven buying and selling.

Gold prices tend to do best in environments where financial stability is decreasing, inflation is increasing, and interest rates are falling. When financial stability is decreasing, people lose confidence in yield-generating financial assets, instead favoring the safety of gold, which has been used for centuries as a store of value. Inflationary pressures erode the value of currencies, increasing the attractiveness of hard assets such as gold. Since gold does not generate any income, it becomes less desirable when interest rates are high. Thus, falling interest rates are a positive tailwind for gold prices.

Since gold miners dig gold out of the ground, their share prices rise in these conditions as the market discounts higher future cash flows. Gold miner's profits are tied to gold prices, as they have a fixed cost of extracting gold. For example, gold miner X may have a total cost of $800 to dig out one ounce of gold. If the gold price rises from $1,000 per ounce to $1,200 per ounce, then the gold miner's profit would double to $400 from $200 even though the gold price is only up 20%. Therefore, when someone is very bullish on gold, he can invest in gold mining companies to take advantage of this price/cost relationship.

The Bottom Line

The VanEck Vectors Gold Miners ETF is most appropriate for traders or investors who are bullish on gold, fear inflation, or a future financial crisis. It is not an ETF made for the casual investor, hoping that an investment over time will surely appreciate.

In the appropriate conditions, GDX can be expected to be one of the few assets that gains value but it is important to pay attention to the management decisions of the companies included in the ETF, as their actions will have the most impact on the ETF as opposed to the actual price of gold, as witnessed by the fund's historical performance.