GDX: A Better Way to Play the Breakout in Gold

Shares of the VanEck Gold Miners (NYSEARCA:GDX) exchange-traded fund are once again beginning to glimmer after a brutal selloff. GDX, which includes the major mining companies, was nearly cut in half from the recent February highs above $30. Like other stocks, gold shares have recovered strongly from the recent lows.

GDX: A Better Way to Play the Breakout in Gold
Source: Shutterstock

But unlike other stocks, gold stocks have the comparative strength of physical gold to continue to fuel the rally higher. Look for GDX to continue to shine bright over the coming months.

The historic monetary stimulus being enacted to battle the coronavirus, both here in the U.S. and worldwide, is unprecedented to say the least. Japan just added a package worth over $1 trillion on the heels of the massive $2.2 trillion U.S. stimulus package. Europe, China, India and virtually all other major countries have enacted similar measures. Once the crisis passes,  the inflationary effect of essentially free money worldwide will likely begin to fuel inflation in a rapid manner. This will be a boon to gold and gold stocks.

The Outlook for Gold Stocks

In my previous analysis on GDX from Feb. 26 I had a bearish outlook for gold stocks. GDX was trading at around $31 and was extremely overbought. It also was trading at a big premium to the dollar and to physical gold. In the interim, gold stocks have dropped 20% while gold itself has rallied to fresh new highs. My previous bearish outlook has now become bullish — because price does matter.

The comparative chart below highlights just how much gold prices have outperformed gold stocks over the past several weeks. GDX stock is normally highly correlated to the price of gold, which makes intuitive sense. Lately, however, that correlation has broken down considerably. Gold is breaking out to 7 1/2 year highs while gold stocks are nowhere near their recent highs. This is by far the largest divergence in the past two years.  Look for that correlation to begin to revert with GDX being a relative outperformer to actual gold over the next several months.

Source: The thinkorswim® platform from TD Ameritrade

GDX is also looking attractive on a technical basis.

Shares of this ETF are back above the $26 level which should now serve as support. They also look poised to break back above the 50-day moving average at $26.34, which could propel a move higher. The 14-day RSI is still far from overbought while Money Flow continues to be constructive but not overdone. A meaningful break out in physical gold could be the impetus to spur gold stocks, and GDX, back towards the recent highs.

Source: The thinkorswim® platform from TD Ameritrade

Implied volatility (IV) has fallen recently but still remains at historically rich levels. This sets up ideally for a covered call trade in GDX-buying the underlying shares and selling calls against those shares to hedge.

GDX Trade Idea

Buy shares of GDX and sell GDX Sep $30 calls for a $26.20 net debit

Ideally GDX closes above $30 at September expiration and the shares are assigned to close out the position for a 14.5% gain (35.16% annualized). If GDX closes below $30 at expiration, then additional calls can be sold to further hedge the position. The short $30 strike along with the option premium received prepostions to exit the GDX above the recent highs near $31.

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 timbiggam@gmail.com.


Article printed from InvestorPlace Media, https://investorplace.com/2020/04/gdx-a-better-way-to-play-the-breakout-in-gold/.

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