HardAssetsInvestor

Written by Brad Zigler  |

August 19, 2010

Mapping Your Way Into The Gold Market

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Is the conventional method for getting gold exposure always best? And how should investors think about risk in the gold market?

Apparently, the lure of the trading floor is more attractive than the beach, since gold traders and investors are trickling back into the market. COMEX open interest has risen by more than 30,000 contracts since its early-August nadir, largely feeding the demand of buyers who've pushed spot prices up by more than $32 an ounce.

Futures haven't been the only beneficiary of prodigal investors' return. Capital is now flowing into, rather than out of, the SPDR Gold Shares Trust (NYSE Arca: GLD). Bullion assets are on the rebound as well. On Wednesday, nearly another tonne was added to GLD's vault holdings.

GLD Money Flow And Bullion Assets

And what of gold mining shares?

From a macro view, the so-called junior shares have done better in August than the established producers—and, in fact, better than gold itself. Since Aug. 5, the Market Vectors Junior Gold Miners ETF (NYSE Arca: GDXJ) has more than doubled the return of the bullion-based GLD shares. Producers proxied by the Market Vectors Gold Miners ETF (NYSE Arca: GDX) outgunned metal, too, but by a narrower margin.

Perhaps that's not so surprising. After all, juniors attract investor attention because of the potential they represent, both for finding gold and as acquisition targets. Certainly, if you've seen the come-ons published by some mining stock touts (see "A Golden Future In Your Mailbox?"), these juniors are just days away from "exploding," "screaming" or "rocketing" to stratospheric heights.

What goes up fast, though, has the potential to come down fast, too. Volatility's sword is double-edged. For that reason, many market observers and financial advisers wonder if junior mining issues are too volatile for investors' own good. To address that question, we've got to look at some numbers.

Conventional Thought, Conventional Numbers

There's no question that gold mining stock prices can vacillate more than bullion's or that of the broader equity market. That's fairly evident if you look at the track record of exchange-traded products since the November 2009 launch of the GDXJ fund.

Gold Mining ETFs Vs. GLD And SPY

The red line tracks the junior mining stock-based GDXJ portfolio's price trajectory; the black line scribes the path of the producer-heavy GDX portfolio. Without even looking at the numbers, you get a sense of the mining ETFs' relative volatility. GDXJ appears to vary more than GDX, though a more pronounced slump near the initiation of the track record kept the GDX underwater until spring. At the same time, the GDXJ portfolio's up spikes seem more pronounced.