GDX: Ugly Gold Miners Starting to Look More Attractive

by Tyler Craig | January 21, 2014 10:27 am

Perhaps no other group of stocks has suffered more during gold’s fall from grace than gold miners. The beleaguered Market Vectors Gold Miners ETF (GDX[1]) has tumbled as much as 70% since the halcyon days of 2011 when gold bugs ruled the Street. Adding insult to injury is the abrupt departure by gold miners from any type of positive relationship with the rest of the stock market.

The drastic descent in GDX was matched by an equally radical plunge in its correlation to the S&P 500. As shown below, the correlation study for GDX has fallen deep into negative territory at -0.75.

GDXcorrelation GDX: Ugly Gold Miners Starting to Look More Attractive
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While many spectators may have written gold miners off as dead money, a number of attractive arguments for the industry can still be made. In essence, things have gotten so bad for GDX that your inner contrarian should be starting to perk up.

A bird’s-eye view of GDX since it began trading in 2006 reveals two items of note. First, some serious price memory exists in the $20 zone. This area successfully reversed the fund’s first plunge amid the bloodbath of ’08, and it appears to have once again acted as support (so far at least). This seems like a really solid level to trade against for a low-risk entry.

The second development that I find incredibly telling is the fact that GDX has given back all of its gains since originally bottoming in ’08. There and back again in roughly five years. All the while gold has only given back about half of what it’s gained since ’08.

Seems as if the selling in GDX has gotten a bit excessive, no?

GDXlongterm GDX: Ugly Gold Miners Starting to Look More Attractive
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By tapping into the leverage offered by option contracts, you can structure a bull call spread that delivers some serious profits if GDX can get back to $30 by year’s end. To provide ample time for a rebound in GDX this year we will use January 2015 options for the position.

Buy the Jan 2015 23 call and sell the Jan 2015 30 call for a net debit around $2. The max risk is limited to the initial $2 and will be lost if GDX sits below $23 at expiration. The max reward is the distance between strikes minus the net debit, or $5 ($7 – $2), and will be captured if GDX sits above $30 by expiration.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.

Endnotes:
  1. GDX: http://studio-5.financialcontent.com/investplace/quote?Symbol=GDX

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