Under The Hood: An Exploration Of Gold Mining ETFs (RING, SLW, AU, IAG, GOLD)

Dominic Maister: “Is it time for investors to start mining for gold?” This question was posed by a Barron’s article a couple months back (and several news items since then). Barron’s wasn’t asking investors to pan for the precious metal in the hills of North Carolina like I did on family vacations as a child. Instead, they were pointing out that gold mining stocks were trading at record lows relative to the price of gold and were therefore worth a look. More recently, when the BlackRock Investment Institute posted their update on the outlook for the remainder of 2012, they agreed that they prefer natural resource equities over physical materials based on current relative valuations.

I no longer spend family vacations in the hills of North Carolina. But as the head of the iShares ETF Due Diligence team, which seeks to help clients differentiate among ETF product offerings and structures, “mining” for investment opportunities is certainly part of my day job. In the case of gold vs. gold miners, it’s hard to dispute that based on historical metrics gold mining stocks currently look cheap relative to the metal, and gold mining ETFs could be worth a closer look by investors.

But, as I’m fond of reminding clients, similar sounding ETFs often have very different exposures. Gold mining ETFs are no exception and the difference can include exposure (or lack thereof) to companies that hedge their gold production, which can reduce the sensitivity of the fund to fluctuations in the price of gold. Some gold miners hedge their exposure to gold by locking in a price to sell their metal in the future. While this practice helps gold mining companies stabilize their cash flows, it is also a big reason why gold mining stocks may not track the ups and downs of gold prices. Importantly, not all companies follow this hedging practice. For the companies that don’t hedge, it means their business fortunes should be more closely tied to the near- and long-term fluctuations in the price of gold.

When it comes to evaluating gold mining ETFs, it helps to know whether the ETF tracks an index that screens for revenues from gold and the amount of hedge to gold prices on a company’s books. At iShares, we launched the iShares MSCI Global Gold Miners Fund (NYSEARCA:RING), earlier this year. The fund seeks to track the MSCI ACWI Select Gold Miners Investable Market Index. This index measures the performance of equity securities of companies primarily engaged in the business of gold mining in both developed and emerging markets. We chose the index because we felt many investors were looking for global gold producers that generate the majority of their revenues from gold production and extraction, and generally do not engage in hedging activity with respect to the price of gold, resulting in companies that have higher sensitivity to gold price performance[1].

The screen means that AngloGold (NYSE:AU), which is involved in the exploration and mining of mineral reserves worldwide, is included in the index. In 2010, 98% of AngloGold’s revenue contribution came from gold and, importantly, AU has eliminated its hedge book. Conversely, these MSCI screening rules also mean companies like Iamgold Corp (NYSE:IAG), which maintains a hedge position, and Randgold Resources (NASDAQ:GOLD), which hedges their production of gold, are not included in the index.

Similarly, many other companies engaged in gold mining are also extensively involved in other businesses and the MSCI index screens work to exclude many of those companies. For example Silver Wheaton Corp (NYSE:SLW), which in 2011 sold over 20 million ounces of silver, but less than 20,000 ounces of gold, is excluded from the MSCI index.

Other gold miner indexes do not necessarily include these revenue hedging or “purity” screens. For instance, the NYSE Arca Gold Miners Index offers exposure to companies involved primarily in the mining for gold and silver. But the index has a less defined focus on whether or not companies hedge their gold exposure and/or are involved in other businesses. This can make the constituents of the NYSE Arca index less sensitive to fluctuations in gold prices. IAG (2.5%), GOLD (4.7%) and SLW (4.8%) are all included in the index.

In addition, the companies eligible for inclusion in the NYSE Arca index are only those that trade on the NYSE or NASDAQ, which means that a foreign company must have ADRs listed through one of the exchanges to become eligible. The MSCI index is comprised of global companies with shares that trade on global exchanges, providing broader global exposure.

For investors looking for exposure to gold without holding the physical asset, whether for tax considerations or to earn additional income, gold mining ETFs can be an option to consider. But before making a purchasing decision be sure to look under the hood and evaluate how sensitive the gold mining companies inside that ETF are likely to be to fluctuations in the price of gold, as well as how diversified their revenue sources are and how much of their revenues are tied to gold production.

Dominic Maister, Director, joined BlackRock in 2010 on the iShares ETF Due Diligence Team. The team reviews models, recommended lists and platforms for partner firms and delivers collaborative implementation guides and timely new product, product enhancement, educational and competitive intelligence content.

Most recently, Dominic was an Executive Director at Morgan Stanley and head of Exchange-Traded Fund (ETF) and Closed-End Fund (CEF) Research. He led a team that provided research commentary on the ETF industry and over 900 ETFs listed in the United States. Under his leadership, Morgan Stanley was recognized by Capital Link as having the best ETF research team in 2009 and 2010. In addition, the team provided research recommendations on over 100 CEFs. Dominic began his professional career at Raymond James Financial and he joined Morgan Stanley in 1998. His prior roles at Morgan Stanley included six years in Equity Capital Market Sales.

Dominic graduated from the John M. Olin School of Business in St. Louis, MO., with a major in business and a minor in legal studies.

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