Thesis Vs Statistics: Trading Market Vectors Gold Miners ETF (GDX) vs SPDR Gold Shares (GLD)

There are times when you trade in conflict.  At the end of March I wrote that I wanted to get ahead of a bigger trend in the Gold Miner vs Physical Gold relationship, anticipating that the spread would move down aggressively.

I’m always much more confident to be short $GDX and long $GLD for a simple structural reason.  If you agree that the a primary driver of holding gold long is a protection against inflation then surely you will be in favor of shorting a group of companies that exchange a physical store wealth for paper assets, right?  This is exactly what gold miners do.  They extract precious gold from the ground and exchange it for paper.  If the purchasing power of dollars is eroded gold miners have no hope of  matching the price performance of the physical asset.  Based on the inflation thesis this spread is probable to move MUCH lower.  Which means I have to step up and sell it here even though it feels unnatural as a contrarian.

Fast forward a month and the exact situation has unfolded.  The spread broke below the lower range it had been trading in; approximately $15 from my post and almost $25 in absolute terms.  I didn’t get as much meat on the trade as I would have liked to.  However, since the move down was so fast and sharp, the trade has now setup for me on the long side.  Why am I jumping in against my thesis?  Statistics.

I still believe that in the long run the $GDX$GLD spread will trade at lower levels than here, just not necessarily in the immediate term.

Below is my best guess as to what will unfold.  Note the gap down tomorrow.

Click image to enlarge

These instruments are very well correlated and co-integrated and have a history of mean reversion.  The separation of these two instruments happens to this magnitude only 0.7% of time (measured on a 2-year timeframe).  That doesn’t mean that it couldn’t move further, but it would be very unusual to move much further from these deeply oversold levels.  The long-term drop in the spread could take many months or years to play out and generate several profitable moves in the mean time.  I feel that this is one of those profitable opportunities.  We shall see.

So here I sit, conflicted.  I have a thesis that states I feel that the spread will trade lower and yet I’m long based on statistics.

Read:  GDX – GLD Spread: Stepping Ahead of the Crowd (Dynamic Hedge)

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