Following a sharp three-day rally that lifted gold and gold mining stocks around 9%, shares of the exchange-traded fund Market Vectors Gold Miners ETF (NYSEARCA:GDX) met some staunch technical resistance yesterday following the Federal Reserve announcement.
With a December rate hike all but a certainty, I look for GDX, an ETF comprised of major gold miners, to struggle to head higher over the coming few weeks.
The initial impetus behind the rally was Friday’s news surrounding the Hilary Clinton email scandal. With the increased odds of Donald Trump becoming the next U.S. president roiling financial markets with uncertainty, a flight towards the normal safe haven of gold began in earnest.
Click to Enlarge Yesterday’s price action in GDX, however, indicated that it may have reached a plateau.
As the chart shows, GDX rallied strongly towards the $26 level before succumbing to selling pressure and closing lower on the day. This type of key reversal pattern, especially following the recent strong rally, is many times indicative of a short term top in the underlying shares.
On a longer-term technical basis, GDX is encountering major resistance at the $26 level. It also filled in the early October gap, which should provide an additional upside headwind.
Click to Enlarge Bollinger Band analysis, which measures sentiment using a volatility framework, is definitely showing overbought levels. The last two times GDX approached these readings proved to be short-term tops in GDX.
One of the benefits of using GDX to position versus individual gold mining stocks is the lowered risk level achieved by having a basket of stocks versus only one. The two top holdings of GDX, Barrick Gold Corporation (USA) (NYSE:ABX) and Newmont Mining Corp (NYSE:NEM) each comprise less than 10% of the portfolio.
Click to Enlarge In addition, many of the gold miners that make up GDX are international as opposed to U.S. based companies, also providing another layer of diversification.
So with GDX looking toppy, I expect a likely consolidation over the next few weeks. To position, a short term bear call spread is the preferred trade structure.
The GDX Stock Trade Idea
Buy Nov $28 calls and sell GDX November $26.50 calls for a 20-cent net credit.
These are the regular monthly options that expire Nov. 18. The maximum gain on the trade is $20 per spread, while the maximum loss is $130 per spread. Return on risk is 15.38%.
The short $26.50 strike is positioned 7% above the Wednesday closing price of $24.76 and also above the key $26 resistance level. I would look to close out the trade on a meaningful break through the $26 area, while looking to keep the initial $20 credit if GDX remains well-behaved.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at tbiggam@deltaderivatives.com.
