The Impending Gold (GDX) Consolidation – How do we play it?

There are a few things you can count on as GDX plumbs new depths, the bugs bug-out, and, in an extraordinarily marginal business environment, the corporate gold movers look for new ways to maintain profitability.

One of those things to look for is additional forward selling.

There’s little wisdom from a corporate point of view in holding on to your bullion store while the metals are sinking. Look for the majors to continue adding to their hedge books.

What’s that mean for GDX?

The result will be a whole lot of downward pressure on silver and gold going forward, in the same way that it has for the last three years. While the commercials essentially shorted their future production in the hope of squeezing every last buck out of their operations as possible, little investors followed suit, and gold lost 40% of its value.

But now it’s a bit different, because with the price of gold approaching its drop dead extraction cost, there’s little left to be squeezed from productivity initiatives and only pocket change to be seized from selling more ore further out the futures curve. As the gold price reaches the cost of production, it simply means more mines close.

GDX miners

In Australia, home to the second largest gold industry on the planet (next to China), mining companies are attempting to extract their highest grade ores from their best mines and to rev up their processing plants. By doing so, they take advantage of efficiencies to help to drive down the cost of production. But they also shorten their mines’ life-spans appreciably.

To put it into perspective, Australian gold output just hit its highest level in eleven years.

More M&A

Still other companies are starting to eye smaller producers or juniors with strong production potential as takeover targets, or, in some cases, are looking at massive mergers to effect more cost cutting synergies and replace depleted or just plain uneconomic operations.

That was the case with the long discussed but to date unsuccessful merger between Barrick Gold and Newmont Mining, two of the industry’s undisputed heavyweights. Those companies have met at least three times in the last decade without succeeding to cut a deal.

Others were more successful – though veritable blockbuster signings have yet to sweep the industry. The best we’ve seen of late was last year’s Agnico/Yamana takeover of Osisko Mining, the year’s sole true power play, with a value of close to $4 billion.

But we’ll see more.

As the price continues to drop.

And the pain becomes exquisite.

shake-up

What will all this mean for the price of gold mining companies? Very likely that they’ll bottom before the price of bullion, as the excitement ratchets up and the deals begin to flow and Wall Street analysts begin to inform us of just how much profit enhancement we can look forward to.

But that’s for another day.

In the meantime, those same companies have an eye on bullion – just like the rest of us – waiting for signs that a bottom has arrived, when they might better cut their deals on the cheap.

So where the heck is the bottom?

No one can say for sure, but it’s not looking imminent.

For one, the technicals for the miners are weak (see below).

Two, the dollar is pummeling every other major currency on the planet – and should continue to do so, so long as the global credit bubble continues to deflate and nations continue to do battle via ongoing currency devaluations.

The U.S. buck just rose to an eleven year high against the Euro last Friday, and that, of course, is bad news for gold because the metal is priced in dollars. All else being equal, gold will fall as the dollar appreciates.

And finally, we see very little hope of an investor led buying spree in the precious metals. After nearly four years of declines and a stock market that keeps hitting new highs, why in the world would ma and pa jumpback into gold like they did five, six years ago. They have no reason.

All eyes are focused on the equity front, and with good reason – that’s where the gains are more probable – even if they are ill-gotten.

Here’s a chart of the miners that we promised. Have a couple of Tylenol at the ready.

Bad GDX News

The Market Vectors Gold Miners ETF (NYSE:GDX) slid 10% in the last two sessions and looks clear to continue.

  • RSI is not yet oversold (red circle),

  • There’s been no sustained turnover of shares (in blue), and

  • All the stock’s moving averages will unfurl completely TODAY and are trending lower.

  • Add to that price action beneath all its MAs and you have the making for some Big Mac size selling in the days ahead.

While it’s not shown here, we also want to report that GDX’s weekly chart is equally depressing.

There, the weekly MAs appear just a day or two from unfurling lower, they’re all trending downward and the weekly RSI is still a long way from registering an oversold read.

Gold funeral

Now let’s make some money.

We’re going to recommend two trades that operate on the same principle but with slightly different strikes and different expiries.

Essentially, we’re going to sell CALLs on GDX just slightly above overhead resistance and use the money to buy PUTs – twice!

Here’s a graphic that helps explain –

GDX Calls, APR JUN

Above the last high at $21.50, where the short term moving average rolls over and locks below the 137 DMA, we’re selling our longer term (June) CALLs…

We’re also confident that in the short term GDX won’t retrace to cover the gap that opened three days ago… So we’re selling our nearer term CALLs there.

Specifically, the trade breaks down as such…

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Options Trader Elite recommends you consider one or both of the following trades – 1) Sell the GDX April 20 CALL for $0.29 and use the funds to buy the GDX April 16 PUT for $0.28. 2) Sell the GDX June 22 CALL for $0.30 and use the proceeds to buy the GDX June 15 CALL for $0.38. Total debit on the trade is $0.07.

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Options Trader Elite recommends you consider one or both of the following trades – 1) Sell the GDX April 20 CALL for $0.29 and use the funds to buy the GDX April 16 PUT for $0.28. 2) Sell the GDX June 22 CALL for $0.30 and use the proceeds to buy the GDX June 15 CALL for $0.38. Total debit on the trade is $0.07.

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With love of the hunt,

Hugh L. O’Haynew, Normandy Research

See what people are saying...

  1. Robert Ruggirello

    Hi guys,

    Just checking…should this have been the June 15 “put”?

    Copy from above:
    2) Sell the GDX June 22 CALL for $0.30 and use the proceeds to buy the GDX June 15 CALL for $0.38

    • Hugh L. O'Haynew

      You’re 100% right, Robert, and thanks.
      It should have said PUT.
      A red-faced (but grateful) Hugh

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