Gold recently suffered through one of the worst five-day periods in recent memory. It suffered the worst day since June 2013 this past Monday, while the major gold stocks that comprise the Van Eck Gold Miners ETF (NYSEARCA:GDX) fell even more. A pullback was probably healthy given the hot rally in gold. Selling begets opportunity, though. Time to use the 10% drop to mine some profits.
InvestorPlace contributor Chris Tyler recommended three metal stocks Wednesday in his excellent analysis. Rather than going with individual names, I am looking at a selection of the stocks that comprise GDX.
Heavyweights Newmont Mining (NYSE:NEM) and Barrick Gold (NYSE:GOLD) comprise 25% of the overall weighting. Canadian-based gold stocks account for roughly 44% of the ETF, while the U.S (18%) and Australia (14%) check in at numbers two and three.
I like the diversity from a risk standpoint. A portfolio of different stocks across multiple countries will have lower volatility than buying an individual name.
Fundamental Focus on Gold Stocks
Eric Fry of Fry’s Investment Report wrote an in-depth analysis of the gold market in a recent research report. The main focus was on the unrelenting money printing being enacted both in the U.S. and worldwide.
Mr. Fry notes that the U.S dollar is at two-year lows and U.S debt to GDP stands at a rather astounding 123%. Given this backdrop it is difficult not to be bullish on the yellow metal. Plus the money printing and monetary easing continues unabated. The fundamentals certainly support higher gold prices and higher gold stocks.
Gold stocks have gone from overbought to oversold in a matter of days. GDX stock reached the lowest readings on MACD since the novel coronavirus crisis lows before firming. Momentum has also gotten to extremes of pessimism but has turned higher. Bollinger Band Percent B traded at a negative number but has since moved back into positive territory. The last two times the indicators were this oversold marked major intermediate-term lows.
GDX stock is still trading above the 50-day moving average at $37.99. There is major downside support at the $39 area which held twice. The price action yesterday was encouraging as both gold and gold stocks regained some traction. A move back to fill in the gap at $42.50 now seems likely.
Normally GDX stock and gold tend to be highly correlated which makes intuitive sense. Since reaching the highs in early August, however, that correlation has broken down considerably. Gold stocks are now under-performing physical gold by nearly 4% over the past 20 days. Look for that relationship to begin to converge with gold stocks outperforming gold over the coming weeks.
I noted earlier I like the lower risk aspect of using an ETF versus an individual stock. I also like lowering my risk by using option spreads instead of buying GDX stock at current levels. A preferred way to position to be a buyer on further weakness is by selling an out-of-the money bull put spread.
Sell GDX December $33/$30 put spread for 65 cents net credit.
Maximum gain on the trade is $65 per spread with maximum risk of $235 per spread. Return on risk is 27.66% 0r 101% annualized. The short $33 strike price provides a 18.77% downside cushion to the $40.63 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 weekly option and volatility newsletter can visit the Options and Volatility Newsletter website.