Considering Our Options – Long $GG In Investment Portfolio

by Enis August 7, 2014 1:22 pm • Commentary

We  own GG in the investment portfolio from an entry at $25.50 in late March.  GG was a stock we first got interested in late last year after it fell below book value amidst the carnage in the precious metals complex. After a nice gain on that initial entry, I bought the stock again in late March with the following rationale:

While the stock has appreciated since then, it still trades at just above book value, even though the outlook for precious metals prices going forward looks much more favorable to me than the free-fall late last year.

On the most recent update on its mid-February earnings report, Goldcorp reiterated the low cost basis of its existing projects.  It also reassured investors that its largest projects were both on-time and on-budget, which is crucial in an environment where investors are closely scrutinizing free cash flow projections over the next few years.

Since then, GG initially sold off as a result of weakness in gold and silver prices in April and May, but has come back to test the $29-$29.50 resistance level over the past month:

GG daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg
GG daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg

As the stock has consolidated in the $27-$29 range, gold and silver have generally gone lower.  That’s a good indication of more demand for the underlying precious metals equities relative to the precious metals themselves, a significant shift compared to 2012 and 2013.

Here is the GDX / GLD ratio over the last few years to illustrate:

GDX / GLD ratio, Courtesy of Bloomberg
GDX / GLD ratio, Courtesy of Bloomberg

While the level of the ratio on its own doesn’t tell you much, the fact that many of the precious metals miners traded well below book value in late 2013 was one indication to us that the underlying stocks were likely a better own going forward than the precious metals themselves.  The ratio has been moving higher in 2014, and I expect that to continue.

The precious metals miners are starting to come into focus for many traders across the market, as the technical situation in GDX is suggesting a big move at a pivotal inflection point.  Phil Pearlman had a good summary this morning of technician Jonathan Krinsky’s thoughts on GDX:

Screen Shot 2014-08-07 at 10.35.49 AM

Here’s MKM Partners Jonathan Krinsky’s daily log of the Market Vectors Gold Miners ETF (GDX) for your perusal.

Krinsky notes:

“1) The GDX chart continues to work through a multi-year base, that has the potential for a long-term ‘inverse head-and-shoulders base’.

2) $27-$28 is the big resistance level to clear, and represents the neck-line of the pattern. A clean break above $28 would imply a measured move up to $36, which would be a 28% move above the breakout.

3) The 200 DMA (24.20) for GDX is rising, which is supportive to higher prices. We would also use a close below the 200 DMA as a reason to back off a bullish stance.”  

Both Phil and Jonathan are favoring a potential breakout rather than a fall at resistance in the coming weeks.

With GG and miners as a group holding flat even as gold and silver declined in July, I feel comfortable holding the long stock position as the setup seems to favor a breakout given that relative strength.  If GG does breakout above the $29 level, I will look to buy a $29 put with Oct or Dec expiration to protect myself from a false breakout over the next few months.  If GG fails near here, I will probably sell the stock on a break below $27.