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Sprott's Thoughts: Rick Rule: An Extraordinary Opportunity

The Market Event Junior Gold Mining Investors Can’t Afford to Ignore

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It’s rare that a practiced junior miner investor has to pay attention to an ETF (Exchange Traded Fund). Most folks who fit into that category already have a well-constructed portfolio, usually with many of the same constituent companies featured in the ETF. But the circumstances surrounding one of the most successful financial products ever created, the Van Eck Vector Junior Gold Miners ETF (ticker GDXJ), are so extraordinary that investors can’t afford not to pay attention.

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For every ETF, the ETF manager is charged with selecting the most promising companies from the representative industry. As the industry moves, the ETF will price accordingly. But the GDXJ has been so popular, has gotten so large, and has attracted so much capital, that it now drives the junior gold miners market: a complete reversal from the norm.

“Because of internal controls, the ETF is constrained to what percentage ownership it can hold of each stock.” A victim of its own success, the GDXJ has practically out-grown the market and has literally been forced to move up-market to purchase larger and larger companies. Rick Rule estimates that the average market capitalization for companies in the GDXJ is now around $3.8 billion – which hardly fits the definition of a junior.  “We prefer companies with market capitalizations far below $1 billion.”

And this market move by GDXJ is creating massive opportunities for investors, particularly as the ETF is forced to “rebalance” in June 2017.

“The circumstance in front of us is such that we think that attractive, small junior companies already in the fund that are going to be reduced in the fund … they are being sold off not because of anything to do with corporate ownership.”

 “We have seen companies come off nearly 25% or 30% merely because they are being reduced in the rebalancing of the ETF; merely because they are too small to take on the kind of capital that is coursing through the fund.”

But, as Rick explains, this is not the only opportunity we see to play the GDXJ.  “There is an extraordinary difference in market performance, market capitalization and share price for the stocks which are in the ETF versus those which are not.” The stocks included in the fund get far more buying than stocks that are not, simply by virtue of their being in the ETF. So we see incredible discrepancies in the market capitalizations of companies: an ideal arbitrage opportunity.

This higher stock price equates to a lower cost of capital for the included companies.  We think they will have to use that bigger share price to buy companies that are OUT of the index to take advantage of the lower cost of capital.

“We think if the valuation arbitrage doesn’t change, there will be takeovers and 50% premiums.”

To view the whole interview with Rick Rule, including greater detail on how to play to GDXJ, please click here.

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