Swap Gold for Gold Miners (GDX)
Time to offload some gold for gold miners? With gold prices having moved in a parabolic fashion, swapping to gold miners could be a wise trade. Some points by Purves of BGC;
We have been structural bulls on gold for three years. We still are and will likely further be for some time to come. None the less, we believe from a trading perspective, it is time to take profits. Our price objective issued on May 13th when gold was at $1,493/oz has yielded a return of nearly 21% in less than three months. We are pleased that these returns were achieved with gold closing beneath our initiating level four only of the 64 trading days that this recommendation has been in play. Currently we believe the gold miners (i.e. GDX) offers excellent value and leverage to gold prices and a superior risk return profile to the metal itself. In the event that gold continues its parabolic move, such a move will be captured by long GDX exposure.
Chart 1: Gold Prices Daily and 150 DMA Jan. 2009 – Present
Rationale For Taking Profits in Gold
1. Gold is now at more than 18% above its key support level, the 150 DMA. Chart 1 illustrates that the only time that the price of gold has exceeded the 150 DMA since then (following the September – December 2009 gold rally), the price spent the following several weeks correcting 15% to the 150 DMA.
2. The Slope of the rally since the recent breakout has been exceptionally steep. The slope of the rally has been unusually steep, some would say parabolic, since it broke out on July 13th. To put this in perspective, the slope during the current break out was .53 (14.8% return in 28 days). Compare this with the Sept. 11, 2009 break out to the Dec. 3, 2009 peak when the slope of the break out was .26 (21.7% return in 83 days).
3. Gold Sentiment at Extreme Levels. Market Vane market sentiment has come in at 90 on August 9th, a frothy level that has typically been an excellent short term sell signal.
4. The prospect for further margin hikes is real. As we have seen in with silver in this past April and with gold today, aggressive rallies are met with aggressive margin hikes. Timing these is of course difficult, but it is the likelihood of margin hikes is much more probable on the back of an exceptionally steep rally.
The Rationale For Allocation to Gold Miners (e.g. GDX)
1. The beta to gold is in secular uptrend. The GDX is a gold derivative and trades with gold prices over the broader term. Despite the recent down tick in the second quarter, the longer term correlations are clearly with gold, and the beta to gold is clearly rising.
Chart 2: Gold Miner Beta to Gold
2. Gold Price/GDX Price At Historic Lows
The current ratio of ~30 is a level we have not since the March, 2009 SPX lows (Chart 3). The rise in this ratio over the last few weeks has been exacerbated the equity market sell off has forced a routing of equities. If equity prices stabilize, this should give a near term boost to GDX stocks. If a new round of macro shocks force equities down, gold prices will continue to escalate and support GDX. Our thesis has been for some time that multi decade rally in gold is a process of currency diversification, a slow and steady process that takes years, not quarters and hence we do not subscribe to the sustained parabolic move thesis. None the less on the back of the U.S. downgrade and the mounting pressures in France and Germany, a parabolic move in gold at this point is possible. By swapping gold for GDX you are still in the gold trade and able to capture this potential move. At the same time, GDX prices are only $4/share above the key $54/share level – a level that has proven to be extremely strong support.
Chart 3: Top Panel: Gold Price/GDX; Price Bottom Panel GDX Price; Jan. 2008 — Present
3. Bad news is factored into prices. The gold mining sector has had a long history of being out favor with equity investors. However last year this sector had been gaining respect as hedges had come off and production and costs were more on track. This year, however, has been another story. The senior miners have had a series of issues among many of the key members. These include Peruvian elections (Newmont, BVN, PAAS), strategically questionable and expensive acquisitions (Barrick/Equinox), mining tragedies and rising Rand (AngloGold Ashanti, Gold Fields, Rangdgold Resources). Further there is a general concern about lowered production levels and higher cash costs as the miners access lower grade ore as well as inflation on several cost points (e.g. oil).
However, we believe that these issues are fully factored into the stock prices. Further, many of these issues are turning out to be not as severe as they may have looked. In Peru, Humala is looking to be much more favorable on mining companies while the retreat in oil prices should help cost levels in the coming quarter. Even the South African Rand has weakened 8% this month. At the end of the day, assuming no major significant drops in production for the group (not something we expect), the real driver of cash flow growth is the long term trend in gold prices.
Gold Prices and BGC Recommendation History
GDX Prices and BGC Recommendation History