Recommendation: Compared to both the S&P 500 and gold, the valuations for the largest cap gold miners have reached an extreme low. Look to buy Barrick Gold Corp (NYSE:ABX), Goldcorp Inc. (NYSE:GG) or Newmont Mining (NYSE:NEM) while sentiment is highly negative.
Option Alternative: Buy the March 2013, 42.50 calls on Market Vectors Gold Miners ETF (NYSE:GDX)
If you are the type of investor who is wary of buying into assets in the headlines, preferring to shop among the out-of-favor and maligned, look no further than gold miners. If you consider yourself cyclically contrarian and have developed the sort of patience to understand the ups and downs of investor sentiment (consider Apple (NASDAQ:AAPL)), then the recent extreme sell-off in three of the largest gold mining stocks may merit attention.
ABX, GG, and NEM: Stocks Only a Contrarian Could Love
Gold itself has been the subject of many bearish articles, with commentators wondering if the long term precious metal bull market is over. A return of global growth, especially within developed markets, would seem to negate the need to hedge with gold since upticking growth will prompt central banks to start reining in their stimulus and reeling in the loose credit they unleashed as their respective economies shift into high gear.
Click to EnlargeBut ABX, GG and NEM have well underperformed the price of gold itself, with all three sitting near 52-week lows. This departure from gold is not uncommon, as miners are more volatile than the price of gold. Over the last several weeks, gold miners –ABX, GG and NEM in particular – have lagged behind gold significantly, reaching a divergence marked by sharp rebounds in the miners. ABX, GG and NEM are the three largest components of Market Vectors Gold Miners ETF (NYSE:GDX) , making up over 33% of holdings. So the extremes in these three stocks have had a big impact on the performance of GDX. I use GDX in these comparison charts for simplicity. Compare first the performance of the S&P with GDX at right.
Gold miners do not follow a consistent pattern of correlation with the broad market, a positive if you are looking for diversity in case the market corrects. GDX goes through periods of diverging from the S&P and follows with sharp rebounds, sometimes when the market is flat or declining. However, at no point in the last 12 months has the divergence reached these extremes with a difference of nearly 42% in yearly performance. These extremes in sentiment – bullish for the market, bearish on the gold miners – typically do not last long.
Click to Enlarge A comparison with GLD also illustrates this extreme divergence. Previous maximum divergence levels between GLD and GDX approached 20% in performance differential. However, the current decline with gold miners is exceeding that divergence. The reactions to these historical divergences were quick reversals to the upside, of 15% and 25%. For short term traders, this extreme bearishness with the miners could be setting up a fast reversal.
Recommendation: ABX, GG, and NEM have had a rough go for the last five months. They’ve suffered appreciably more than gold itself. But if you have a contrarian streak that prefers to get in positions when they are out of fashion, gold miners may also provide a degree of protection since they have lower correlations than other sectors to the S&P if the market cannot break through its 2000/2007 double top. We recommend GG, ABX, or NEM at current prices, however, GG may be the best play in the short term as it has been the most defensive.
Option Alternative: The GDX March 42.50 calls are currently trading in the $1.35 range and a new long entry there looks attractive. We would expect GDX to rally a little less than individual gold stocks but it is also less likely to move down quickly on unexpected news.
John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.