Gold Sends Signal to Leading Mining ETF

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’re 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 in early March 2022, when it ran out of upside steam. The December futures contract traded to $2,091.40. The correction that followed took the continuous contract to a $1,679.80 low and the December futures to a bottom of $1,696.10 on July 21, 2022.

On July 21, 2022, 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 the March 2021’s $1673.70 low, as the continuous contract fell to $1,679.80 per ounce. The bullish key reversal above the March 2021 low was a sign that gold was ready for a recovery. The price was at the $1,785 level on August 1, with the continuous contract above $1765.

ETF Exposure

The VanEck Gold Miners ETF (GDX), which holds a portfolio of the world’s leading publicly traded gold mining companies, remains the most liquid and leading gold mining ETF product.

The top holdings of GDX include:

The GDX portfolio contains many of the world’s top gold mining companies. At the $26.31 level on Aug. 1, GDX had net assets of over $10.62 billion and trades an average of nearly 7.7 million shares daily, making it a highly liquid ETF product. GDX charges a 0.51% management fee.

Early Stages of a Gold Rally?

The last significant rally in the gold futures market took the price of nearby COMEX futures from $1673.70 in early March 2021 to $2,072 in March 2022, a 23.8% increase.

The graph shows that the GDX ETF rose 35.8% from $30.64 to $41.60 per share over the same period as the gold mining ETF outperformed the gold futures market on a percentage basis. The decline to $24.38 per share when gold made its most recent low was a 41.4% correction, and gold futures declined by 18.9% over the period.

GDX tends to magnify price moves in the gold futures arena on a percentage basis.

If the July 21 bullish key reversal pattern and higher low in the gold market lead to higher highs in gold, the odds favor outperformance by the GDX gold mining ETF product. Meanwhile, for over two decades, gold’s trend has been bullish.

The graph illustrates that gold futures reached rock bottom at $252.50 per ounce in late 1999. Since then, every correction has been a buying opportunity in the precious metal.

Charts source: Barchart

The GDX product only began 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. The GDX product 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 behavior all suggest the rally in gold could be in the early stages. Gold mining shares and the GDX ETF product could outperform the metal over the coming weeks and months.