ETF rebalancing a bumpy ride for junior gold miners

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In an unprecedented move, one of the most popular junior gold miner exchange-traded funds is set to rebalance on Friday after growing too large for its market. After months of volatility, miners and investors alike are preparing for even more uncertainty.

Cursed by its own success as a $4-billion (U.S.) ETF in a $30-billion space, VanEck Vectors Junior Gold Miners ETF (GDXJ-N) began to expand beyond the index it tracks, the MVIS Global Junior Gold Miner's Index. Combined with VanEck's Vectors Gold Miner ETF, (GDX-N), the company is nearing the significant shareholder status point of 20-per-cent ownership in several companies, many of which are Canadian, which means special filing requirements and significant trading restraints.

As a result, the ETF began buying shares in companies outside of its index and on April 13, VanEck announced that the index would be expanding to keep up with the ETF's growth. The ETF will now buy gold miners with a market cap in the range of $75-million to $2.9-billion, from its earlier range of between $75-million and $1.6-billion.

But this also means the fund will have to sell over 50 per cent of its shares in some smaller companies to make room for the additions. After the announcement, the fund's units fell sharply, from $38.06 prior to the announcement to as low as $29.33 in the following weeks. The aggressive selling pressure has led to a roller coaster for the junior mining sector as shareholders try to make sense of the changes.

"There was a slow creep up, but then the selling is going much faster. Money is flying out of the fund right now," said Benjamin Chiu, a quantitative equity trader at BMO Nesbitt Burns Inc. who has been carefully watching the fund and the changes slated to be made.

"I've been in the mining industry for 20 years and I've never seen anything like this," said Patrick Donnelly, president of First Mining Finance Corp., which the GDXJ owns 15 per cent of. "When the price of gold goes up, all the money's going into these ETFs, leading to pretty crazy distortions overall."

Mr. Chiu confirms that a rebalance of this size is a rare event and can leave shareholders scratching their heads due to its sweeping nature.

"When the performance of your fund declines due to a structural change … This change, even with a diverse investment, is affecting all the underlying names in your investment," said Mr. Chiu.

As for miners, Mr. Chiu warns that the impact on some of the smaller companies in the fund will be significant.

"[They'll be] less liquid with less people involved with them. The downside could be quite strong," said Mr. Chiu. "Some of the smallest names like the bottom 10 in the ETF are not very liquid now, therefore when the ETF sells them, there is an opportunity where there could be significant impact on Friday."

Mr. Donnelly remembers the day the Vancouver-based company was added to the GDXJ on Dec. 16, 2016. While the move was exciting at the time, Mr. Donnelly has remained wary of how things could eventually turn.

"It gave me pause. Something I've learned is that, yeah, it's great to get in but when they push you out, it can be very difficult for a company," he said. "The good news is that it'll be a temporary phenomenon."

Mr. Donnelly added that because First Mining Finance shares are "very liquid," the impact won't be felt as much as it will for companies that are less so.

It's estimated that as part of the rebalancing, GDXJ will sell over 38 million First Mining shares, according to a report by BMO Nesbitt Burns. In mid-march, the company's shares were trading at around $1 but traded as low at 57 cents after the fund announced the changes.

Toronto-based Wesdome Gold Mines Ltd. had only been added to the GDXJ on March 17, a month before the announcement of its rebalancing. Initially, Wesdome president and chief executive officer, Duncan Middlemiss was ecstatic about being included into the ETF.

"Be careful what you wish for," said Mr. Middlemiss. "We loved coming into it but we're not enjoying leaving it."

The day it was added to the GDXJ, Wesdome's stock price rose to $4.40 with 22.94 million shares traded. Since then, its stock price has gone down, hovering just over $3 and dropping to as low as $2.99. It's estimated that the GDXJ fund will sell nearly 9 million Wesdome shares.

With little control over what happens next, Mr. Middlemiss prefers to see Wesdome's time in the GDXJ with a glass-half-full approach.

"Beyond the initial buying frenzy, I have to say that our inclusion into the GDXJ has elevated our profile," Mr. Middlemiss said. "It has brought in a wider range of investors. The U.S. exposure has been good."

Meanwhile, on the retail side, First Mining Finance's Mr. Donnelly sees a silver lining to a drop in stock prices.

"It's almost like the salmon run is coming, in terms of investors," Mr. Donnelly said. "It's an opportunity to get some quality names for a good price."