Why Rick Rule believes ‘factors-based’ approach makes SGDJ the best junior miners ETF

Sprott recently launched a second ETF called the Sprott Junior Gold Miners ETF (NYSE Arca: SGDJ).

Why should investors care about Sprott’s new ETF?

I met with Rick Rule, Chairman of Sprott US Holdings and John Ciampaglia, Sprott’s Head of ETFs, to learn more. They stressed the importance of ‘factors-based’ ETFs that use customized criteria to select and weight stocks in a particular sector.

“Investors like ETFs because they have lower management fees than mutual funds,” said Rick. “They provide intra-day liquidity and have transparent holdings. The trouble with traditional gold mining ETFs is that they are market cap-weighted. The higher the market-value of a company, the higher the weighting it represents in an index. In a sector like gold mining, where there is an extreme range in the quality of companies, this quantity-based approach doesn’t make sense.”

“We take a different approach in our ETFs by providing investors with access to innovative indexes that are designed to outperform passive market cap-weighted offerings,” John explained. “Each Index is designed using specific FACTORS that MATTER™ for a particular sector. These customized factors are selected because they have historically proven to be strong predictors of long term stock performance.”

Sprott’s first ETF, the Sprott Gold Miners ETF (NYSE Arca: SGDM), seeks to provide investors with a better way to invest in senior gold miners. It uses a factor-based index that emphasizes companies with the highest revenue growth and lowest debt-to-equity ratios. As a result, the ETF is not simply made up of the companies with the highest market capitalizations.

In smaller gold companies, too, research by Sprott and its partner Zacks Index Services showed that market capitalization was not a good indicator for performance. A junior gold company can issue lots of new shares and become very large but mismanage its projects and destroy shareholder value.

After the success of SGDM, which was focused on big miners, Sprott launched SGDJ, which focuses on earlier stage companies. This new ETF uses its own customized index that is geared towards junior gold stocks.

Right now, the most widely-owned ETF for junior gold stocks is based on the Market Vectors Global Junior Gold Miners Index. This index focuses on small and micro-cap stocks, weighting them based on market capitalization.

“We took a very different approach in co-designing the Sprott Zacks Junior Gold Miners Index,” said John. “First, our Index focuses on more advanced-stage junior companies than the Market Vectors Global Junior Gold Miners Index because we don’t believe you can invest effectively in micro-cap companies on a purely passive basis. Investing in early-stage companies requires significant technical and qualitative assessment that even a rules-based index would be unable to evaluate. Our Index favors junior and intermediate producers over early-stage exploration companies where the historical success rate is very low.”

As Rick put it, “There are over 2,000 junior exploration companies around the world and most of them are destined to fail for geological reasons alone. The idea of investing passively in a basket of small and micro-cap companies and weighting them based on their size is problematic in the gold sector.” Rick said this is why this new ETF is so significant. Until now, there hasn’t been a way to own a junior gold mining ETF that favors some companies over others based on qualitative factors. “I want to own companies based on their track record of creating value, not on how big they are,” said Rick.

SGDJ tracks the Sprott Zacks Junior Gold Miners Index, comprised of 30 to 40 companies with market capitalizations of between $250 million and $2 billion. The Sprott Zacks index methodology seeks to emphasize companies with the strongest relative revenue growth and price momentum. These two factors have historically been strong predictors of long-term stock performance for junior gold miners.

“In my experience, the real measure of success for a junior miner is not the initial discovery but the progression of the project to the development stage,” said Rick. Revenue growth is an important factor that measures how a junior company is progressing towards becoming a producer.

The second factor is price momentum, a well-documented asset pricing anomaly. It assumes that high-performing stocks will continue to outperform, while weak momentum stocks will continue to under-perform.

For junior gold stocks, strong relative price momentum could be driven by positive developments such as the advancement of a new project or positive drill results. “Price momentum can identify leaders and laggards within the sector,” John explained. “We believe it is an effective way to look at companies in the sector that are not yet generating revenue.”

“Historically, price momentum is a better indicator when the market is more discerning about which stocks to own,” said John. “In a broad bull market, past performance is less important to investors. In bear markets, investors become more careful. Past performance matters more.”

To summarize, the Sprott Junior Gold Miners ETF selects stocks through the following methodology:

Emphasizes companies with the highest relative revenue growth and the strongest relative price momentum
Market capitalization between $250 million and $2 billion, representing around 30 or 40 gold companies
The Index is reconstituted semi-annually so that the latest company results are reflected in the composition and weighting of the Index
“Sprott believes that SGDJ provides investors with a more thoughtful strategy for investing in junior gold miners based on their merit, not their size,” says Rick.

By Henry Bonner ([email protected])
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For more information, please visit www.SprottETFs.com.

1 http://www.etftrends.com/2014/12/sprott-gold-miners-etf-hits-100-million-in-assets/

2 http://http://www.alpsfunds.com/performance/SGDM

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