As Gold Mining ETF GDX Rally Loses Glitter, Trading Opportunities Arise

The VanEck Vectors Gold Miners ETF (NYSEARCA:GDX) has certainly shined bright in recent days. GDX stock is up nearly 7% in the past week as investors scramble for safe havens like gold and gold mining stocks. Coronavirus fears have driven physical gold to multi-year highs. The rally, however, has now come too far, too fast. Time for the gold miners and GDX to lose some luster.

As Gold Mining ETF GDX Rally Loses Glitter, Trading Opportunities Arise
Source: Shutterstock

GDX is composed of the largest gold mining stocks. Newmont Gold (NYSE:NEM) and Barrick Gold (NYSE:ABX) account for nearly 25% of the ETF. Gold and gold mining stocks are normally highly correlated, although mining stocks tend to exhibit more volatility, both to the upside and downside.

Gold and gold mining stocks are usually inversely correlated to the U.S. dollar. A stronger dollar is a detriment for gold prices (and gold stocks) in U.S terms. A weaker dollar is bullish. Last year, however, saw that correlation break down The dollar strengthened and gold moved both higher until last November. This year has seen a reversion back to traditional norms.  The recent sharp drop in the dollar has fueled gold prices to multi-year highs.

Click to Enlarge
Dollar weakness may quickly change course, especially if the coronavirus news improves at all. The safe haven play of bonds and gold can swiftly reverse in a bout of profit taking. Given the extremes of both gold and the dollar over the past few months, a reversion to the mean looks to be the probabilistic play. Look for the dollar to strengthen and gold stocks to weaken in the next several weeks.

Technical Take

GDX stock is now very overbought on almost every metric. The moving average convergence/divergence (MACD) has exploded higher to the loftiest levels of the past year. Momentum has reached a similar extreme. The nine-day RSI is pushing toward 80. Bollinger Percent B is well above 100. GDX is now trading at the biggest premium to the 50 day moving average in the prior 12 months. Prior instances when these indicators aligned marked significant short term tops in GDX stock.

Click to Enlarge
Source: The thinkorswim® platform from TD Ameritrade

More importantly, GDX stock had a big reversal yesterday. Shares opened at $30.48 before heading to $31.16, then switched course and closed well off those highs at $29.97. This type of price action is many times indicative of a short-term top in the stock. The buyers have become exhausted and the sellers are in control. It is an even more powerful signal given the magnitude of the previous rally.

A pullback in GDX seems likely given the extremes in gold, gold stocks and the dollar. Any hint of an easing in the coronavirus fears could be a catalyst to send gold and GDX lower.

Stock traders should look to short GDX on any strength. The initial downside profit objective would be a move back towards the break out area at $29.50. The ultimate objective is a retest of the 50-day moving average near $28.50.

Option traders may want to take advantage of heightened implied volatility (IV) and sell an out-of-the money bear call spread. The April $33/$35 call spread should bring in about 35 cents net premium. Maximum gain on the trade is $35 per spread. Maximum risk is $165 per spread. Return on risk is 21.21%. The short $33 strike provides a 6.25%  upside cushion to Monday’s $31.05 closing price of GDX stock.

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 

Article printed from InvestorPlace Media,

©2022 InvestorPlace Media, LLC