Gold mining ETFs look set to benefit from a bullish signal coming from the futures market.
As a hybrid precious metal that functions as both a currency and a commodity, gold has been around as a means of exchange for thousands of years.
While governments can print fiat currency to their hearts’ content, gold supplies are limited to the amount extracted from the Earth’s crust.
Central banks, monetary authorities and governments validate gold’s role in the worldwide financial system as they hold the precious metal as an integral part of their foreign currency reserves. Over the past years, governments have been net buyers of the metal.
Since the amount of the asset is limited, gold ETFs quickly found a place in the industry as an easy way for investors to gain exposure. And in recent weeks, we are seeing growing ETF investor appetite.
In late July, gold displayed a technical pattern that could lead to another leg higher after the bull market of over two decades reached a new peak in early March 2022 and corrected lower. When gold’s price rallies, the companies that mine the metal tend to outperform gold on a percentage basis.
A bullish reversal in gold
The COMEX gold futures contract reached a record high of $2,072 an ounce in early March 2022, however, it ran out of upside steam. The December futures contract traded to $2,091. The correction that followed took the continuous contract to a $1,679 an ounce low and the December futures to a bottom of $1,696 on 21 July.
Chart 1: Historical price of gold, as at 3 August
Source: Gold Price
On 21 July, December gold futures fell below the July 20 low and closed above the previous day’s high, resulting in a bullish key reversal pattern on the daily chart.
The longer-term snapshot shows that gold’s low was above a critical technical support level at March 2021’s $1673 low, as the continuous contract fell to $1,679 an ounce. The bullish key reversal above the March 2021 low was a sign that gold is ready for a recovery. The price was at the $1,785 level on 1 August, with the continuous contact above $1765 an ounce.
The VanEck Gold Miners ETF (GDX), the US-listed equivalent of the $663m VanEck Gold Miners UCITS ETF (GDX), invests in a portfolio of the world’s leading publicly traded gold mining companies and remains the most liquid and leading gold mining ETF product.
Chart 2: GDX top 10 holdings, as at 3 August
The portfolio contains many of the world’s top gold mining companies. GDX has $10.6bn assets under management (AUM) and trades an average of nearly 7.7 million shares a day, making it a highly liquid ETF product. It charges a 0.51% management fee.
Early stages of a gold rally?
GDX tends to magnify price moves in the gold futures arena. Highlighting this, the last significant rally in the gold futures market took the price of nearby COMEX futures from $1673 in early March 2021 to $2,072 in March, a 23.8% increase, while GDX jumped 35.8% over the same period.
Meanwhile, it fell 41.4% in its most recent correction while gold futures declined by 18.9%.
If the bullish key reversal pattern on 21 July and higher low in the gold market lead to larger highs in gold miners, the odds favour outperformance from GDX. Meanwhile, for over two decades, gold’s trend has been bullish.
Chart 2: Price of gold in the past five years, as at 3 August
Chart 1 illustrates that gold futures reached rock bottom at $252.5 an ounce in late 1999. Since then, every correction has been a buying opportunity in the precious metal.
Chart 3: GDX historical performance
GDX only started trading in 2006 so it does not have the same history as the gold futures market. However, three factors suggest that a rally in gold will lead to outperformance in the gold mining shares.
First, gold mining companies invest substantial capital in projects that yield exponential returns when the gold price moves higher.
Secondly, investor sentiment in the gold market tends to cause a herd of buying in gold mining shares when the metal’s price trends higher. And lastly, mining is a highly speculative and leveraged business.
While individual mining shares can offer the same leverage, they can experience the idiosyncratic risks created by specific mining properties and management decisions. GDX diversifies and mitigates those risks by investing in a portfolio of companies.
The recent bounce in gold from a higher low, the bullish technical trading pattern and gold mining shares’ historical price behaviour all suggest the rally in gold could be in the early stages. Gold mining shares and GDX could outperform the metal over the coming weeks and months.
This story was originally published on ETF.com
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