Dear Profit Alert reader,
I would love nothing more than to talk more about the coming data explosion today.
It’s going to be right up there with cloud computing, smartphones, and all the other major tech trends. All of which have made fortunes for investors who jumped on and rode them to the top.
Also, the recent sell-off has been great for the stocks which will benefit from all that too.
And I promise, we’ll return to that next time.
Right now there are more pressing matters which offer some excellent short-term gains with very little risk.
It’s a unique trade that is absolutely perfect for a risk-minded investor.
Here it is.
My Favorite Gold Trade Of All Time
The markets seem to have gone completely haywire in the last few days.
The floor on the NYSE shut down yesterday. No reasonable explanation has offered yet as to why.
China stocks collapsing. Three weeks ago the Chinese government quietly curbed margin buying to quell surging Chinese stocks. It worked too well.
Greek stocks are hitting new lows too.
Now the next crisis de jour is already emerging. Puerto Rico looks like it has maxed out it’s credit card. The S&P Puerto Rico Municipal Bond Index all the way back to 2009 levels and still falling.
It’s ugly. Investors are scared. They’re acting emotionally. And they’re pushing markets to extremes.
One of the most extreme situation is in the gold market and it’s creating a short-term trading opportunity which has always paid off.
Of course, I realize, when I say “gold,” you’re probably a bit turned off.
That’s wise. Precious metals have been in a bear market for more than four years now and there’s catalysts for a major turnaround on the horizon.
As Richard Russell of the Dow Theory Letters brilliantly summizes, ”In a bear market, everybody loses, and the winner is he who loses least.”
That’s why this gold trade works so well. It has nothing to do with the direction of gold.
It’s not a bet on rising or falling gold prices. It’s actually more of a bet on the market being highly and temporarily irrational.
Here’s how it works.
The prices of gold and gold mining stocks are highly correlated.
Gold mining stocks are basically leveraged bets on the price of gold since their earnings are so closely tied to gold prices too.
In a normal market, the two move in tandem. Gold goes up, gold stocks tend to go up. Gold goes down, gold stocks down.
Once every year or two though, this relationship gets completely out of whack and it creates a very low-risk/high-profit opportunity.
Right now is one of those times.
I track the relationship between gold and gold stocks by using the SPDR Gold Trust Shares (GLD), which tracks the price of gold, and the MarketVectors Gold Miners ETF (GDX), which holds all major gold mining stocks.
The ratio of how many GDX shares one GLD share will buy, or the GLD/GDX ratio, is the key.
This ratio has historically been pretty flat because of the natural and rational correlation of the prices of the pair. But right now it’s reached an extreme point.
The chart below shows the GLD/GDX ratio over the last two years:
As you can see, the ratio has reached it’s current extreme high of 6.59 (meaning one GLD buys 6.59 GDX) only twice in the past two years.
This means gold stocks are extremely cheap relative to gold.
Last time the ratio got this far away from its normal level was last October. The ratio hit a high around 6.8.
It didn’t stay that high for long. Over the next three months it fell to 5.25.
Had you played the ratio by shorting GLD and buying and equal dollar amount of GDX, you would have made a relatively low-risk net 25% return.
Not bad for three months.
The situation right now is very similar.
A Market of Extremes
Again, this is not a play on the price of gold. Precious metals are in a bear market and should be treated as such until proven otherwise.
This a play on the relationship of gold and gold mining stocks.
It’s largely market neutral (so you don’t have to worry about China, Greece, Puerto Rico, etc.) and that’s what makes it my favorite gold trade.
More importantly, there could be an even bigger advantage here for you too.
I realize that most investors hate shorting stocks of any kind.
Any time in the past I recommended betting against things like 3-D printing, rare earths, oil, and agriculture when they were at extreme highs, the response from many of your fellow readers is they don’t do that.
It’s something most investors just don’t want to do. But this trade is a way to learn how to do it and get comfortable with it while you still can.
Because with stocks up 200%, the Fed warning it would like to end the party, and many overvalued stocks out there, there are going to be some big winners and some big losers.
Shorting stocks is a skill which will really come in handy at some point in the next few years to profit from the losers.
Next time we get back together we’ll look at some of the winners.