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Is The Junior Mining Sector About To Implode?

by Pining 4 the Fjords, TF Metals Report:

Understand this is just one trading and investing Parrot’s opinion, but I have read numerous interpretations/spins/takes on the GDXJ rebalancing, the JNUG implications, and none of them have seemed to me to honestly get to the core issues or implications of this major event as regards the immediate future of the junior mining sector (and possibly the entire sector as a whole, in the short-term). So in this piece I thought I would lay out, part by part and fact by fact, what I think might be implications that nobody is really talking about, either because they have vested interests in the sector and are afraid of spooking investors, or because they simply haven’t thought through the implications or imagined what may happen if the dominoes fall. Understand that this is speculative, but also understand that to dismiss this thesis, you must factually explain why the ‘cause and effect’ I am about to lay out will not take place. It is not my intention to discourage or frighten people, simply to warn them of a possibility that seems to me to be entirely realistic based on current fact and evidence. If I am wrong or in error, I gratefully welcome different interpretations of the data- the entire point of this is for all of us to do well in the end!

The Summary Case in a Nutshell:

GDXJ, which already is 5% GDX (not juniors) and contains other significant holdings that are not really juniors as well, has now announced a rebalancing June 17th whereby they will be selling a long list of smaller junior miners (and not buying more) and adding larger-cap companies to their index. In short, this “junior mining” ETF is becoming essentially “10% large miners, 50% mid-cap producers, 40% larger juniors” ETF. The juice that used to be provided by the smaller miners is now either gone or at least largely diluted.

This announcement will hit a big list of small mining companies in two ways. First is the obvious disgorging of GDXJ shares (representing 2.6 billion dollars of selling, or about 6-8 trading days-worth of share volume per company, all selling that has to be absorbed the market). The second, however, is the double-whammy this has on each of these companies in that (a) individual investors are/will sell their shares in anticipation of this, and (b) it will discourage future investment in these companies since everyone knows you cannot count on that big flow of GDXJ money ever coming back in to these stocks. This will depress the entire sector as a whole to some degree. Say goodbye to that easy pension, casual investor, and 401k money. From now on, those companies are niche investor targets only. Bad sign.

JNUG, the 3x ETF based on GDXJ, has been the “risky bet” trading vehicle of choice for traders who want high risk/high reward exposure to gold, so much so that JNUG is now a 1.2 billion dollar behemoth. JNUG, however, leaks value vs the underlying GDXJ over time and this is reflected by a forthcoming 1 for 4 reverse split in the shares. It is feared that this split may signal even more leakage, putting traders on edge.

The GDXJ rebalancing away from the juniors means that going forward, JNUG will not offer anywhere near the “juice” to traders it once did in terms of 3x exposure to the potentially fast-moving small junior stocks. Without this additional pop, why trade or hold JNUG? Why be in this leaky vehicle where the underlying GDXJ has torpedoed its underlying portfolio by (a) announcing its sales ahead of time and (b) essentially moving away from the very thing (exposure to the potentially high-flying small companies) that once made it attractive? These things will likely cause traders to move away from an increasingly sluggish JNUG.

If traders leave JNUG, it will be devastating to GDXJ- the swaps and futures that allow JNUG to function represent roughly HALF the market cap of the 5.3 billion dollar GDXJ. If traders decide JNUG is no longer the rocketship it once was and hence is not worth the trouble, and just 20% quit trading JNUG, this is the equivalent of half a billion dollars fleeing GDXJ… if 40% quit trading JNUG, it’s the equivalent of a billion dollars exiting GDXJ. These types of outflows, in a short period of time, could mean serious price carnage in such a small sector.
The thesis of this piece is that this chain of developments has the potential to devastate the junior miners in the short run, coming on top of the effects of the GDXJ rebalancing.

What did they know, and when did they know it?

This decision didn’t happen overnight. The folks who run GDXJ had to have made this choice, and understood the potentially deadly ramifications for the entire sector, quite some time ago. I think I know when.

Back in February I saw something in the charts that truly baffled me, a disconnect of a magnitude that I haven’t seen in 15 years of pouring over gold, silver, and mining charts on a near daily basis. There was a startlingly odd disconnect between the miners and the metals, when from Feb 10- Feb 26 Gold was up 3.6% yet the juniors were down 8%!!!

This bizarre, counterintuitive move was capped off by the big smash in miners on Monday, Feb 27 when GDXJ was hit for an additional 11% in a single day. When gold is flat over ten trading days, yet the juniors and down a whopping 20% over that same time on no news, something is definitely up. What is interesting is a tidbit our fellow Turdite Murphy sent me. In the final 15 minutes of trading that day of the big drop, Monday Feb 27, 775 million dollars of GDXJ shares changed hands… That is equivalent to the entire average daily volume of shares traded in that ETF in just the final 15 minutes of trading. On “no news”.

This is pure speculation, but I think this time period is when this decision was made- in a rising gold market, the juniors fell by 8% and ultimately 20% for no particularly good reason known publicly. This is when big money got out, and left us holding the bag. Sorry, but we are the last to know and that’s how it works.

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