Gold ETF shake-up to create winners and losers

There has been a flood of money into the leading exchange-traded fund (ETF) focused on the global junior and mid-tier gold sector, VanEck’s Junior Gold Miners ETF (GDXJ). And why wouldn’t that be the case? The US dollar gold price is up 12 percent since the start of the year and the local price is now more than a spectacular $1700 an ounce.

Investors after leveraged returns to gold’s price strength through investment in junior and mid-tier gold equities have pumped an additional $US1.4 billion into GDXJ since the start of year, taking it to a heady $US5.3bn – up from $1bn at the start of 2016.

The ETF – for an expense ratio of 0.56 percent - seeks to mimic the price and yield performance of VanEck’s Market Vectors Junior Gold Miners Index.

Love ‘em or hate ‘em, ETF’s are increasingly big players in the investment space. But their success is throwing up structural issues as the weight of money in relatively small investment spaces like global gold creates headaches when it comes to finding a home for the funds within their specified mandates.

That has been an issue of late at GDXJ, with the rise of global geopolitical uncertainty and a good dose of global financial uncertainty fuelling a flood of money into the fund.

With limits on how much of a stock it can own (individual weightings in the fund are capped at 8 percent), GDXJ’s investable universe has become too small.

Its response has been to flag a change in its mandate to include the ability to turn some of the flood of funds into the larger producers (minimum market cap of $US750m), currently the preserve of another VanEck ETF, the $US12.5 billion GDX fund which mimics the NYSE Acra Gold Miners Index.

Apart from highlighting the hunger out there for gold exposure as a hedge to global uncertainty, the changes being made to the GDXJ has implications for Aussie gold stocks currently in the fund (there are 11 of them out of 48 companies the fund is invested in) and for those in its big brother GDX (there are nine Aussies amongst the 51 companies in which it is invested).

Macquarie’s equities desk has done some number crunching on the GDJX’s changed mandate and reckons it will trigger some $US2.5 billion in market turnover as the portfolio adjustments are made in both of the VanEck ETFs.

And as might be suspected, there will be winners and losers on the ASX from the changes. Macquarie nominated (from within its coverage universe) OceanaGold (OGC), Northern Star (NST), and Evolution (EVN) as potential winners. Losers – that is those facing a potential negative impact from the changes – were listed as Alacer (AQG), Beadell (BDR) and Perseus (PRU).

The three winners (OGC, NST and EVN) had previously been removed from the GDXJ because they had pushed past the fund’s $US1.5bn market cap limit. The change in GDXJ’s investment universe means all three are likely to be re-instated into the fund while maintaining their positions in the GDX.

Macquarie said the main negative from the change is that the expansion of the upper market capitalisation limit would result in the existing constituents in the GDXJ suffering a down weighting in the ETF to incorporate the new additions.

And looking to future beneficiaries, Macquarie reckons mine developers Gold Road (GOR) and Dacian (DCN) were the most likely inclusion in the GDXJ index in future, although it suspects that market liquidity requirements could be a limiting factor.

Dacian excites in its boring phase

On the subject of Dacian, it can be said that Macquarie knows a thing or two about the Mt Morgans gold project developer, given its Macquarie Capital arm was lead manager and underwriter to the company’s recent $110m equity raising at $2 a share.

Despite the firm gold price, Dacian has drifted back to $1.84 a share for no particular reason other than it is seen to be in the “boring’’ phase of being fully funded (with the help of a $150m debt facility) for the rapid-fire construction of the project, with first production in early (calendar) 2018.

It got a little less boring earlier in the week when Dacian executed the engineering, procurement and construction contract with GR Engineering.

It comes with a maximum guaranteed price of $107.1m, with any savings below that to be shared between Dacian and GR.

More to the point though is the contract secured a $23m capital saving, reducing the total capex for the project to $196.9m from the previous $220m estimate previously.

The win was enough for Macquarie’s equity desk to pump out an updated research note which came with a 12-month price target on the stock of $2.90 – some 57 per cent higher than where it currently sits.

Nothing boring about that. There is also nothing boring about the ongoing exploration program in and around Mt Morgans which as Macquarie put it, remains a key potential upside catalyst for the stock.

Recent results suggest that the Cameron Well deposit could shape up to be a second open-pit ore source from the project while recent drilling at the Jupiter mine area is also showing open-pit potential at the East Heffernans and South Cornwall deposits.

“Our development scenario for Mt Morgans only incorporates the Jupiter open pit reserve and we believe the potential for additional open pit material from either Cameron Well or around Jupiter is high,’’ Macquarie said.