Historical Moves In Gold Complex

• Posted by DynamicHedge
• on July 2nd, 2013

The relationship between $GLD and $GDX used to be reasonably predictable and range bound for long stretches. That was until gold and gold miners started an ugly downtrend. Since then, correlation has almost entirely dissolved.

I’ve never been a big fan of gold mining stocks. Juniors can be good for lotto tickets, but gold miners will always underperform the physical commodity in the long run for two reasons. First, they don’t work as an inflation hedge because their business is to exchange hard assets for paper, and second since most of them operate in unstable regions, they’re subject to unfavorable optionality like nationalization and labor unrest.

Take a look at the long-term ratio chart of $GDX / $GLD. Not only does it highlight this brutal underperformance of the miners, but it also indicates a breach of the former historical lows in the spread. This is the lowest point in the ratio since the inception of the products, and also a two standard deviation move based on the relationship over the last two years.

When historic price discovery like this takes place it usually means a significant inflection point is at hand. This could work out in a couple ways: either prices in the entire gold complex resolve higher or the bottom completely falls out. The higher probability option, given the tone towards owning gold at the moment, is that the inflection point resolves in higher prices. This might look like a large bounce in an emerging down trend or a long-term bottom in the overall uptrend. On the other hand, if the bottom does come out of the gold complex, look for many mining company bankruptcies and months and months more selling pressure. This is a far lower probability outcome in my opinion. Remember, inflection points can be synonymous with knife catching. If that is your game, stick with the underlying $GLD because $GDX has proven it can fall faster and further if things do go south.

For those looking for a pure lotto play and really want to buy mining companies in spite of the structural disadvantages, check out $GDXJ. $GDXJ has underperformed the more senior $GDX and is the most beat up sector in the gold complex due to the speculative nature of junior mining. For the royal gamblers among us, $GDX is a high risk play with lots of volatility (very rough ride) and lots of potential reward.

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