The gold bulls are back.
The price for the metal just breached $1,400 a troy ounce, its highest level since 2013. The move opens the possibility that investor appetite for the metal is rising.If we are indeed entering a major bull market for the metal then savvy investors should consider buying smaller cap gold mining stocks rather than either the metal itself or the larger miners.
The easiest way to do that via the VanEck Vectors Junior Gold Miners exchange-traded fund (GDXJ - Get Report) , which tracks a basket of smaller, so-called junior gold mining firms.
Part of the recent surge in the price of gold is because the dollar is weakening. When the dollar increases or decreases in value, then gold will tend to do the opposite.
We've seen that happen over the last month as the Federal Reserve started to take a more dovish stance on raising interest rates. The expectation that interest rates will not be rising soon has sent investors fleeing the dollar in favor of other assets such as gold.
Specifically, over the last month the dollar index, which measures the strength of the greenback versus other currencies, has slipped from a high of 98.1 to 96 recently, according to data from Yahoo.
Over the same period, the SPDR Gold Shares (GLD - Get Report) ETF, which holds bars of solid bullion, rallied by 10%.
That surge in gold prices will continue as long as the dollar stays weak, according to chart analysis experts.
"If the Dollar Index is below 98 we want to continue to aggressively own precious metals," states JC Parets, founder of technical analysis firm AllStarcharts.com.
In general, the mining stocks do better than gold when the price of the metal rallies.
But the smaller mining firms should outperform the larger ones, as long as the bullion price remains in an uptrend, says Don Coxe, chairman of Chicago-based financial firm Coxe Advisors.
Here's why:
Smaller cap stocks, such as those in the junior miner ETF, tend to have lower liquidity than do larger cap ones, which means that it takes fewer buyers to move the share prices either higher or lower for the smaller companies than for the larger ones.
In other words, the juniors tend to be more volatile than the majors, jumping faster in rallies, and falling further in routs.
For example, in the middle of 2014 when the gold price sank, the Junior Gold Miner ETF performed far worse than did the Gold Miner ETF. The junior gold miner ETF also has approximately one-third the volume of the gold miner ETF.
Now that gold prices seem to be on the march higher we can expect juniors to race ahead of the major gold stocks.
The other big part of the bullish case for small-cap stocks is that as the price of gold rallies the larger companies are more likely to gobble up the smaller ones.
To some extent, all mining companies are worth the value of the gold in the ground that they own. The problem is that as they mine that metal they need to replenish it or risk having no resources left.
This is a more significant problem for larger firms such as $31-billion market cap Newmont Goldcorp (NEM - Get Report) than it is for say the $1-billion market cap Harmony Gold Mining (HMY) .
Newmont is expected to produce up to seven million ounces of gold a year over the next few years versus Harmony, which this year will likely have an output of slightly less than 1.5 million. Or put another way, just to keep its resource level static, Newmont must add around seven million ounces a year going forward, whereas Harmony only needs to find another 1.5 million.
Smaller companies may be able to prospect for new ore deposits but larger ones will tend to have a hard time discovering large enough deposits to make a difference. Hence the larger companies will likely decide to buy the smaller ones so bidding up stock prices of the smaller ones.
"There will be numerous stocks in the junior gold miner fund that will be bought by big companies," says Coxe.
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