Trades

Gold’s Day in the Sun is Finally Here

Google+ Pinterest LinkedIn Tumblr

If there was ever a time for world leaders to take a vacation, it would be right now. The ugly public disagreements we just saw between the leaders of the G7 nations this past weekend were only the cherry on top.

Presidents Trump and Xi have been going back and forth with ever-increasingly hostile actions. First tariffs, then using the word “enemy” in Tweets and now broken promises and even lies.

Over the last few weeks, investors have been on their seats waiting for the next shoe to drop in the trade war. The on-again-off-again fourth round of tariffs have only sent fragile stocks and bonds into a tailspin.

The bond market has effectively broken, with a nearly perfectly flat yield curve. 30-year Treasuries now pay out less than 3-month ones. It doesn’t take an expert to see this is not healthy.

Stocks too have been whipsawing back and forth. Some investors seem to be trying to find safety in historically recession-proof plays. Procter & Gamble, for instance, is up more than twice as much as the S&P 500, with a 31% year-to-date performance.



Others, seem to just be fleeing into cash or those long-dated bonds.

There is one area that has been on fire throughout this whole period, however: gold. Gold prices have jumped well above their six-year highs of late… and only seem to be climbing:

Screen Shot 2019-08-28 at 2.01.58 PM.png

Without other great investment options for risk-averse market players, gold offers safety. With interest rates turning negative in much of the Western world and speculation that it could someday soon reach the U.S., gold offers a lifeline to investors.

Gold mining companies, as you can imagine, have seized on this long-awaited turnaround for their product.

Here, you can see how the VanEck Vectors Gold Miners ETF (GDX) has absolutely taken off this summer:

Screen Shot 2019-08-28 at 2.02.03 PM.png

This fund holds all of the major players in the gold mining business: Newmont, Barrick, Newcrest, etc. Each of these companies have had their share of problems with gold stuck below $1,300 per ounce for most of the last few y ears. Now that we’re seeing $1,500-plus gold prices, they are taking off.

The question, however, is whether or not this can continue? To answer that, first consider where else investors might go from here.

With rates stuck in the mud, a bickering Fed, and geopolitical tension so thick you need a steak knife to cut it, stocks will certainly remain a volatile option for the foreseeable future. That just leaves precious metals.

There’s still room to run here. In fact, gold miners themselves could see wild growth in the next few months. Consider this…

Gold miners are essentially just a way to leverage gold prices. When gold itself goes up in value, as it has now finally done, those miners’ in-ground and recently produced resources become ever more profitable. In turn, margins break wide open, offering even faster bottom-line growth.

So, if it takes $1,200 to pull gold out of the ground, $1,300 gold prices offer just $100 per ounce in earnings. But $1,500 gold prices offer $300 in net income. That’s three times the income for these companies in just the last two months!

Unfortunately, trying to predict which gold miners are going to take the most advantage is nearly impossible. To truly leverage gold’s current rally, miners have to be already in production or in an expansion phase at their mines. Each one is slightly different.

But there is a way to play this. As noted, the overall industry is still undervalued. As those expanded margins start showing up in quarterly earnings announcements, funds like the GDX are going to continue climbing.

And instead of simply buying shares and waiting for that growth to come, there’s a trading strategy that lets you leverage this growth just like miners leverage gold prices.



A Strategy For Short Term Bulls

A bull call spread is a type of options trade that involves buying a call option on a stock you believe will increase in value and then selling a second call with a higher strike price.

The income from that second call helps offset the cost of the first. This reduces the total amount of money at risk for the duration of the trade in exchange for a top ceiling on the maximum potential profit of the trade.

You can see how this works here:

image1

Source: The Options Industry Council

For GDX, there’s room to run. And even if gold remains above $1,500 for the next few months, there’s no guarantee we’ll see the kind of rally in precious metals we have in past economic downturns. After all, these mining companies’ stocks are still stocks. There will be volatility.

With a bull call spread, you can take advantage of the continued growth, without risking the farm.

Let’s look at a specific example to show you just how much you could make right now with a bull call spread on GDX…

A Specific Trade on GDX

Right now, a trader could buy an October 18 $31 call on GDX for $1.40 per share and sell an October 18 $33 call for $0.73 per share for a cost of $0.67 per share. Since each contract is worth 100 shares of GDX, that’s a net debit of $67.

That $67 is the total amount at risk for the duration of this trade… from now until October 18. So, even if peace were to somehow blossom across the world, the trade wars end, the economy begins growing again and the Fed stabilizes the bond market… $67 is all the trade could lose.

If, however, gold continues to outperform those other asset classes, this trade could pay out even more.

To find the maximum profit potential here, take the difference in strike prices ($33 – $31 = $2), and subtract the cost ($2 – $0.67 = $1.33). On 100 shares of GDX, that’s a return of $133.

In other words, this trader would be sitting on a 199% return on the amount he has at risk if shares tick up from $31 to $33 over the next two months.

Considering how they have already risen $10 since early May, another $2 would not be hard to come by.

This trade offers a chance to nearly triple your money on an underlying investment that’s currently exploding, all with reduced risk and both macro and microeconomic support.

This rare opportunity is exactly what precious metals investors have been waiting for over the last six years. Now, you can take advantage.

Write A Comment