Dollar priced in gold falls, mining stocks now giving a “buy” signal.

A week ago, I stated that the dollar priced in gold “has not yet fallen to touch or pierce the blue line. This means that the uptrend is still young and not fully established. It may reverse over the next week or two or it may continue up”.

So let’s look at what has happened over the past week. Here is a chart of the gold price inverted to show the dollar priced in gold

dollar-gold-10-22-16

The dollar has fallen in price over the last week, and has now pierced the 10 day moving average. If it bounces up from here, this would be evidence that the uptrend is firmly established and will probably continue for a few more weeks. However, we would normally want to wait for a second pullback before making a short-term leveraged trade.

If you are trying to accumulate gold for the long-run, however, now is still a good time to sell your dollars and buy gold. The price of gold has only risen by about $16/ounce. At around $1,268/ounce, this is still a very good buy compared to the $1,366.00 you would have paid in late June/early July and that you are likely to pay again in January.

So what can you do if you already have gold? Is there a good trade you can make to multiply the gold you already have? Today, I’ll discuss one such opportunity: gold mining stocks.

Gold Mining Stocks.

There is a general misunderstanding about gold stocks that is very prevalent. Many people believe that mining stocks offer an investor leverage to the gold price. In other words, there is a perception that gold stocks tend to outperform gold when gold is in a bull market and under-perform it when gold is in a bear market.

However, this is not always true. For example, gold had its biggest run in recent history from 2009-2011. But during this time, gold mining stocks broke even in dollar terms and fell in gold terms.

In order to know whether gold mining stocks are a good trade, we have to use technical analysis…just like we would with any other asset.

So here is a chart of the Market Vectors Gold Miners ETF (stock symbol “GDX”) over the past year, priced in gold.

gdx-gold-10-22-16

Mining stocks have been on a tear this past year, and have moved up so quickly that they were almost impossible to buy without taking a huge risk. But now they’ve fallen to the area between the 200-day and 100-day EMAs.

The best time to buy would have been a week or two ago, when they were still below the red line on this chart. Still, they are only slightly higher than they were then and are still a great buying opportunity.

Of course, there is a possibility that the year-long bull market in gold stocks could be coming to an end. Maybe we are about to see a moving average crossover and a long-term fall in the gold-price of mining stocks. This is unlikely. But still, we should always prepare for the possibility. So if we are going to make this trade, we need to place a stop at around 0.016 oz., just below the previous low of 0.018 oz. This will limit our risk enough to make the trade worthwhile.

There is also the possibility that gold stocks could bounce off their previous high, shown on the chart at around 0.023 oz. in the middle of August. Because this is a reasonable possibility, and because we need to place our stop at around 0.016 oz. to limit our risk, we could argue that the trade only presents a 1:1 reward/risk ratio and therefore is not a good idea.

But I think there are reasons why GDX is still a good buying opportunity.

In order to understand why, take a look at a chart going back to 2012.

long-run-gdx-10-22-16

Given the speed at which GDX has risen this year, it is likely that it could break through it’s previous high. If it does so, the next place where it is most likely to stop is 0.03 oz. (30 mAU). This is more than a 2:1 reward/risk ratio if we place our stop at 16 mAU.

So here is one way that you could trade this opportunity without taking too much risk:

  1. Sell 33% of your gold account and buy as many shares of GDX as you can get. For example, 33% of a 2,000 mAU (2 Troy ounces) account is 660 mAU (0.66 oz.). At the current price of 19 mAU per share, this would allow you to buy 34-35 shares, depending on whether you round up.
  2. If the gold-price of GDX falls to 16 mAU per share, sell all of your GDX shares and buy gold. In the example above, at a price of 16 mAU per share, 35 shares will allow you to buy 560 mAU (0.56 oz.) for a loss of 0.1 oz. or $126 worth of gold.This is only a loss of 5.25% of the account.
  3. If the GDX price rises to its previous high of 23 mAU, sell half of your GDX shares and buy as much gold as you can with the cash you get in exchange. In the example above, half of 34 would be 17 shares, which would allow you to buy 391 mAU (.395 oz.). This would give you an initial profit from half your trade of 61 mAU (391 minus 660/2) or about $77.25 worth of gold. Once this milestone is reached, your risk will then have fallen from 0.1 oz. to 0.039 oz. However, getting ready to implement the next step will further reduce your risk to zero.
  4. If the GDX price rises to 23 mAU but then falls back to it’s current price of 19 mAU, sell the second half of your shares and buy gold. This will reduce your risk to zero, and you’ll end up with a profit of 3.05% from having sold the first half earlier.
  5. If the GDX price rises to 23 MAU, then keeps climbing until it reaches its high from October 2012 of 30 mAU, sell the other half of your GDX shares and buy gold. In the example above, 17 shares would give you 510 mAU, for a profit from your second half of 180 mAU. This would be a total profit from the trade of 241 mAU (61 from the first half and 180 from the second half) or 12.05%, for a reward/risk ratio of a little over 2:1. In dollar terms, this is $305.21 at today’s dollar price.

If the profit in the example above doesn’t sound like enough motivation to make the trade, it’s important to realize that the amount of gold to be made depends on the trader’s account size. If the account size is 4 oz. instead of 2 oz., the profit to be made is double, etc. You could also make double if you were willing to risk 10.5% instead of 5.5%, which would require you to begin the trade by selling 66% of your account instead of 33%.

Over the next few months, I’ll track this potential trade. And together, we’ll see how well it paid off.

In the meantime, I hope you all have a good weekend. If you have any questions or comments, please leave them below.