Slight Preference For GDX Over GLD

London (Apr 2)  Seeking Alpha and Twitter have been all abuzz about the recent underperformance of the gold miners relative to gold. Readers of our recent articles on GDX vs. GLD will know that we were not taken by surprise. GDX and GLD go through periodic divergences which can last longer than anyone might expect. We believe that "the market can stay irrational longer than you can stay solvent."

This is our fourth article that addresses an indicator that we have developed to address the relative value between the the SPDR Gold Shares ETF (NYSEARCA:GLD) and the Market Vector Gold Miner's ETF (NYSEARCA:GDX). The purpose of this indicator is to determine which ETF represents a better risk-weighted investment at a given time.

In a prior article, we unveiled what we believe is a much better indicator than the traditionally used (and possibly meaningless) GDX/GLD. Rooted in the fundamental costs of gold production, we prefer the ratio GDX/(GLD-86) to inform our gold exposure allocations.

Value At Risk

In each of these articles, we get the predictable troll who opines, "you don't make any sense, GLD went up 10%, and GDX went up 20%. Why did you say that GLD was better?" This opinion is based upon a misunderstanding of Value at Risk ("VAR") in general, and our proposed basis for investing in GLD and GDX in particular.

Over many time periods, the beta of GDX to GLD is around 3.0. This means that - on average and especially over a longer period of time - the value of GDX is leveraged 3X to the value of GLD. As another confirmation of this relative risk, on March 31st, the implied volatilities at-the-money GLD options was 10.5% and the implied volatilities of GDX options were 30%.

Assuming these volatilities, then we should understand that $10,000 invested in GLD has an annual VAR of $1,000, and $10,000 invested in GDX has an annual VAR of $3,000.

Source: SeekingAlpha