Chart of the Day – GDX: Messin’ with The Gold Diggers

by riskreversal January 11, 2017 12:18 pm • Chart of the Day

The inverse relationship between the price of gold and the U.S. dollar is something that makes intellectual sense, but there is no shortage of historical data that suggest the two can trade in the same direction at the same time together (read here).

Earlier in the year though the inverse correlation hit the highest levels in more than two years, and since Sept 1st, Gold (GLD) has declined 10%, while the U.S. dollar index (DXY) has risen nearly 8%:

GLD vs DXY 6 month chart from Bloomberg

Year to date the DXY is up a little less than 1%, and 1% from the 14 year high it made last week, while GLD and the Gold Miner etf (GDX) are up 3% and 8% respectively.

I want to now switch gears to the GDX, given its propensity to outperform the performance of GLD. The one year chart of the GDX shows the recent counter-trend rally that at its highs last week was up 20% from the mid Dec lows which marked a 40% peak to trough decline from the August highs. There is little doubt that the downtrend from August is an important near term technical level, while the next real support level:

GDX 1yr chart from Bloomberg

So back to the dollar. What could be the thing that keeps the dollar moving higher, and cause new lows in gold and gold miners? That would be a rise in interest rates. The Fed has two meetings in Q1, Feb 1st and March 15th. The Fed Funds Futures are pricing a 12.5% probability that the Fed will raise Fed Funds rate 25 bps, and a 33% chance that they raise at the March meeting.  If economic data continues to surprise to the upside, the probability of an increase will increase, which should also cause the dollar to make higher highs, and in this fairly confident economic situation, should cause gold and miners to decline.

Looking out to March expiration in GDX, playing for a near term break-below the downtrend from August, and below support that dates back to April 2015, and new lows below the Dec low at $18.58, one might consider the following defined risk options trade:

Trade: GDX ($22.25) Buy March 22/ 18 put spread for 1.20
  • Buy 1 March 22 put for 1.50
  • Sell 1 March 18 put at 30 cents

Break-Even on March expiration:

Profits: gains of up to 2.80 between 20.80 and 18 with max gain at or below 18

Losses: of up to 1.20 above 20.80 with max loss at or above 22

Rationale: This trade idea targets a pullback in GDX in continuation with a technical trend we’ve seen since the highs in August 2016. The risk reward is nearly 3 to 1. If the etf was able to hold support at its 50 day moving average (21.60) then the trade should be kept on a tight leash as the breakeven is nearly a dollar below that level. On a move lower patience will pay off below the breakeven of 20.80.