Miners Are Where Gold’s Profits Lie

by Nick Atkeson and Andrew Houghton | June 12, 2012 11:38 am

With Western Europe moving into recession, weak consumer demand in the West is connected to weakness in manufacturing in Asia, which is connected to weakness in natural-resource demand from places such as Australia and Brazil. This is what makes for slowing global growth.

This process is occurring largely because of uncertainty in the financial system, driven by the crisis in the euro and European sovereign debt. Banks are holding back from lending, the private market is not willing to invest and the public is shifting money out of stocks and into bonds as a result of financial uncertainty.

We started the month with the possibility of Greece dropping out of the eurozone, a Spanish bank run acceleration, slowing growth in China, the possibility of an Obamacare decision by the Supreme Court and rising fears of a “fiscal cliff” in the U.S. The fiscal cliff is defined as the expiration of the Bush tax cuts and the imposition of spending cuts mandated by last year’s debt-ceiling deal that could occur at the end of this year unless new legislation is passed.

In the context of all that, gold is starting to recover from its lows as people perceive it as a safer investment.

But what’s working even better than gold is the gold-miner sector. Off its May lows, the Market Vectors Gold Miners ETF (NYSE:GDX[1]) is up 20%, while the SPDR Gold Shares ETF (NYSE:GLD[2]) is up about 6%. Gold-mining stocks have underperformed gold for several years, so they may be just beginning to play catch-up now.

Most importantly, we have seen strong bullish options flow in the GDX in recent days. Last week, there was an opening buyer of 13,000 July 49 calls versus a total open interest in this line of about 1,000 contracts. Then we saw buyer of 17,000 June 50 calls and a seller of 15,000 Sep 45 puts (remember, selling puts is also a bullish strategy).

What may be driving these trades is the rising probability that the Fed may offer further easing measures to make sure the U.S. economy continues to grow. The Fed will conclude a two-day meeting on June 20 and may formally announce a new program. Investors are buying gold and gold-mining stocks as they see further devaluation of paper currencies such as the euro and U.S. dollar.

To play this, go long the GDX Sep GDX 49 Calls at current levels, which are around $2.40.

For those of you with level 2 options-trading approval, we recommend opening a GDX Sep 49-56 bull call spread in which you buy to open the GDX Sep 49 calls and simultaneously sell to open in a 1:1 ratio the GDX Sep 56 calls.

We’re looking for GDX to rise about $4 from current levels.

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

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