After decades of trading in the opposite direction as stocks, gold has become more positively correlated with equities
by Bernard Goyder and Monique Mulima
After tumbling from an all-time high of almost $4,400 an ounce less than a month ago, gold is starting to make a comeback. And that rebound bodes well for shares of miners, a cohort of stocks that acts as a levered bet on the metal’s fortunes, according to an analysis from 22V Research.
After decades of trading in the opposite direction as stocks, gold has become more positively correlated with equities amid concerns over a weakening dollar and insatiable demand for the precious metal from central banks.
“You’ve had gold trading like a meme stock for a while,” Jeffrey Jacobson, head of derivatives strategy at 22V, said in a phone interview.
Jacobson said that the VanEck Gold Miners ETF tends to move at double the rate of the gold price itself. The fund has returned over 125% since the start of the year, which compares favorably with a still-impressive 57% gain for the SPDR Gold Shares ETF’s (GLD) over the same period.
With stocks higher this week as Congress works to bring the longest government shutdown in US history to a close, investors are starting to take a more bullish stance on gold as well. In the view of some strategists, the dip from record highs last month was more about profit taking than an end to gold’s bullish run.
“With the selling behind us, gold is well-positioned to continue rising on its way to another round of record highs,” Tim Hayes, chief global strategist at Ned Davis Research, wrote in a report on Tuesday.
Jacobson made the case for using derivatives on gold ETFs to bet on a further recovery, writing in a Nov. 10 note that it’s an “optimal time to consider adding upside option structures to play for a move back higher.”
Indeed, later that day, one trader spent more than $35 million on an options position that benefits if GLD sits above $390 by mid-December. The trader bought what is known as a call spread, entering into a position that will benefit from a modest increase in the ETF’s value in the coming weeks while sacrificing gains if gold goes beyond its all-time high.
Yet Jacobson believes that calls on GDX, the ETF tracking miner stocks, are a better value than options on GLD because there has been less of a rush by investors to buy upside options on the miners than there has been for the metal itself, based on a valuation metric known as skew.
“If you think that gold will move higher, that miners will regain leadership, and now they’re trading at under 2X in terms of call skew, then that’s another reason that you can make the case to own calls or call spreads in GDX to play a continued bull move higher,” he said.
When it comes to the underlying stocks, gold miners Newmont Corp., Agnico Eagle Mines Ltd. and Barrick Mining Corp. have all seen gains of around double that of spot gold prices this year. Even the departure of a chief executive officer, ongoing issues in Mali and a third-quarter revenue miss weren’t enough to deter investors in Barrick, with shares gaining more than 130% so far this year.
The three gold miners are expected to see a decline in gold production this year, yet with surging bullion prices, revenue is still expected to grow by double-digit percentages, while adjusted earnings-per-share are expected to increase by at least 79% year-over-year, according to analyst estimates compiled by Bloomberg.
Of course, there are risks to consider when getting bullish on gold miners. GDX is a highly volatile way of playing the so-called dollar debasement trade — the idea that gold’s rise is because of a structural shift away from the US currency.
Because of the huge range of possible outcomes, implied volatility is high — that’s the option market’s way of warning that an ETF that has more than doubled in less than a year could easily move sharply in the opposite direction.
“You should expect potentially large movement in these stocks,” said Dean Curnutt, chief executive officer of Macro Risk Advisors, a broker-dealer and research firm. “A high implied volatility is telling you that the range of outcomes is just very wide,” he said in an interview.
Copyright Bloomberg News
