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The mining sector encompasses the extraction (mining) as well as primary and secondary processing of metals and minerals. It includes producers of aluminum, gold, steel, precious metals and minerals, and diversified metals and minerals. The sector is highly cyclical and extremely competitive.

Though industrial mining is back on track after a decade given strong growth in emerging markets, in particular China and India, shaky domestic growth, still depressed job numbers and unresolved European problems keep the performance in check (read: Two ETFs for the Muddle Through Economy).

Demand/Supply Imbalances

The demand for most metals is increasing rapidly, but the supply is limited due to a lack of investments in new mines over the last few years. The mining companies are now making huge investments to bolster their supply chains. These companies are looking for exploration of new mines with all the necessary permits.

However, in the rising energy and raw material costs environment, increasing productivity and reducing costs are the two keys to success for these companies (read: Could This Be The Year For These Mining ETFs?).

Given the cyclical nature of the metals industry, low-volume high-cost producers need to generate sufficient cash or ensure a strong borrowing position during market peaks to survive the market troughs. In this regard, consolidation or mergers and acquisitions (M&A) is considered the best way to keep the input cost low and obtain synergies and economies of scale.

A drop in commodity prices and lingering economic conditions has however resulted in lower M&A activity in the first half of the year. Instead, expansion in low-cost countries will ensure lower labor costs and help tap their growth potential. Overall, mining companies are expected to benefit from lower production cost and increasing supply once the market booms.

Mining ETFs in Focus

For investors seeking to play in this sector, there are currently four mining ETFs targeting different industrial metals in basket form. Though these ETFs have underperformed the broad market, recent simulative measures by Fed have raised the prospects of potential upside (read: Commodity ETFs in Focus as Fed Unleashes QE3). These often act as a leveraged play on the underlying metals, making them excellent picks in bull market environments:

SPDR S&P Metals and Mining ETF (XME)

Investors seeking domestic exposure could find XME a good choice to play. It is the largest and most popular fund in the metals and mining space with AUM of $996.3 million. The fund seeks to replicate the performance of the S&P Metals and Mining Select Industry Index, before fees and expenses.

The fund holds 41 securities in the basket, with large focus on small cap stocks. It enjoys diversification benefits, as it puts only 33.6% of assets in the top 10 holdings with weighting of around 3% each. Compass Minerals International (CMP), Hecla Mining (HL) and Royal Gold (RGLD) are the top three elements in the basket (read: Three ETFs with Incredible Diversification).

From various commodities perspective, the product is heavily weighted towards steel with 34% share, followed by diversified metals and mining (23%), precious metals (21%), coal and consumable fuels (15%) and aluminum (7%). 

Launched in June 2006, the ETF is the low cost choice in the space, charging 35 bps in fees per year. It trades in good volumes of more than 3.4 million shares per day, suggesting little in extra cost in the form of bid/ask spreads.

iShares MSCI Global Select Metals & Mining Producers Fund (PICK)

Launched in January 2012, this fund provides exposure to both developed and emerging metals and mining markets. The ETF seeks to match the price and yield of the MSCI ACWI Select Metals & Mining Producers Ex Gold & Silver Investable Market Index, before fees and expenses.

The fund largely focuses on large cap companies that are involved in the extraction and production of diversified metals, aluminum, steel, and precious metals and minerals excluding gold and silver.

It allocates nearly 51% of the assets in the top 10 firms, with a 12.3% share in BHP Billiton Limited (BHP - Analyst Report) followed by a 7.4% share in BHP Billiton plc (BBL) and 7% in Rio Tinto (RIO). This suggests that company-specific risk is somewhat high in the case of PICK, as the top 10 holdings dominate half of the returns. In total, the fund holds 296 securities.

The product has a definite tilt towards broad metals and mining as these make up for 64% of the assets. Other more specific metals – steel, precious metals and aluminum - make up for the remaining portion of the basket.

The fund is widely diversified across various countries, as UK takes the top spot followed by Australian and American securities. These three nations make up for nearly 52% of the assets (see more in the Zacks ETF Center).

Though the product is quite inexpensive charging 39 bps in annual fees, a wide bid/ask spread could raise the total cost of the fund. PICK trades in small volumes of 36,000 shares per day managing to attract assets of $218.3 million thanks to the newness of the product.

EGShares Emerging Markets Metals & Mining ETF (EMT)

Investors looking for emerging market exposure in the space can find EMT an exciting pick. The fund offers non-U.S. dollar commodity exposure to the largest miners of copper, nickel, platinum, palladium, iron ore, and coal in the emerging markets.

The product often benefits from the emerging market currency appreciation, such as the Brazilian real, South African rand and Russian ruble, versus the U.S. dollar. 

The fund tracks the Dow Jones Emerging Markets Metals & Mining Titans 30 Index, holding 30 securities in the basket. It is highly concentrated in the top 10 firms, as it allocates no less than 58% of its assets to them.

Vale (VALE) enjoys the top position with at least 10% share while MMC Norilsk Nickel and AngloGold Ashanti (AU) take the next two spots in the basket with a combined share of nearly 14%. While large caps account for a substantial 78% of the assets, mid-caps take the remaining portion of the basket. 

The fund has a slight tilt towards steel followed by precious metal, metals and mining, coal and alternative energy, and aluminum. From a country perspective, South African companies occupy the largest share in the basket with around 23%. Brazilian, Chinese, Russian, Indian, Mexican, Polish and Chilean companies make up the remaining portion of the basket. 

The fund charges higher fees of 85 bps per year. With volume of only 5,000 shares per day, the wide bid/ask spread increases the cost for the product. Launched in May 2009, the product so far managed assets of $10 million, although it does pay out a solid yield making it a potential income destination for investors (read: Top Three Emerging Market Dividend ETFs For Income And Growth). 

Global X Junior Miners ETF (JUNR)

This is the newest product in the space, initiated by Global X in September 2012 (read: Global X Debuts Junior Miners ETF (JUNR - ETF report)). The ETF looks to give broad exposure to small cap firms in the mining world from across the globe. The fund seeks to match the performance of the Solactive Global Junior Miners Index, which is a benchmark of small cap mining firms that are engaged in producing, smelting or refining of coal, copper, gold, iron, nickel, silver, titanium.

The product holds 97 securities in the basket and is highly diversified across individual securities, sectors and countries. The top 10 holdings account for nearly 22% of the assets, with none of the securities holding more than 3% share. Precious metals enjoy the top position in the basket comprising roughly three-fifths of the assets (read: Precious Metals ETFs 101). The rest goes to broad metals and minerals, coal and alternative energy, steel, and aluminum.

In terms of a national breakdown, Canada and Australia take the top two spots at 34% and 26% of assets, respectively. The U.S. (18.4%), the UK (7.3%) and China (4.3%) round out the top five, suggesting that a host of nations from around the globe receive sizable chunks in the portfolio.

Thanks to the newness of the product, it trades in small volumes of nearly 8,800 shares per day. This illiquid nature raises the cost for this fund in the form of a wide bid/ask spread beyond the expense ratio of 0.69%. The ETF has, however, delivered solid returns and an above-market dividend, making it a decent choice in the space.   

Provided below is the summary of the ETFs discussed above for those seeking a side-by-side comparison:

 

Fund Name

Inception Date

Issuer

AUM (in millions)

No. of Holdings

Assets In Top 10

Expense Ratio

Dividend Yield

YTD Return 12/20/12

XME

Jun-06

State Street

$1,001

41

33.60%

0.35%

1.29%

-12.9%

PICK

Jan-12

iShares

$226

296

50.78%

0.39%

0.63%

-13.8%

EMT

May-09

EGShares

$9.66

30

58.31%

0.85%

4.18%

-0.6%

JUNR

Sep-12

Global X

$3.00

97

22.12%

0.69%

2.64%

5.6%

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