How to Play the Breakout in Gold ETFs

By David Fabian  FEB 11, 2014 12:35 PM

If you decide to dip a toe into precious metals, do so with a risk management mindset that takes into account the prior lows that were established at the end of last year.

 


Gold ETFs appear to be shaking off an abysmal 2013 that saw the yellow metal lose more than 25% of its value. The combination of tepid inflationary statistics and rocketing stock prices put downward pressure on gold prices last year. This, in turn, prompted investors to withdraw billions of dollars from gold-related exchange-traded products.

However, these fortunes may soon be shifting with the return of volatility in stocks that is sending money back to traditional safe havens like Treasuries and precious metals. The SPDR Gold ETF (NYSEARCA:GLD), which tracks the daily spot price of gold bullion, has gained more than 5% year-to-date since Friday's closing price. The more aggressive Market Vectors Gold Miners ETF (NYSEARCA:GDX), which tracks stocks engaged in the production of gold, has gained more than 13% this year.



A quick look at the chart above shows that GLD has just recently broken out of a point of consolidation and appears to want to attack the 200-day moving average (smooth red line). Gold prices have traded below this important long-term moving average for nearly all of 2013 and a push back above that region would likely signal additional capital to take notice of this trend change.

Traders at this point are likely to be cautious given that nearly every rally attempt last year stalled and resulted in lower prices. According to recent data from IndexUniverse, the year-to-date asset flows have still been slightly negative for both GLD and GDX, which means that investors have yet to pile back into this beaten-down sector. However, there is a strong case to be made that buying this commodity well off its highs could be a profitable long-term investment decision for value seekers.

I have been admittedly tepid about the price action of gold recently because its downward momentum has been difficult to overcome. However, the recent signs of breaking out above that long-term downtrend have me warming up to this sector.

One potential opportunity for GLD this year is as a volatility hedge in your portfolio. Recent price action suggests that declining stock prices act as a buoy for gold prices, which could make it a diversification strategy for non-correlated returns. If that trend continues, we could see additional spikes of strength in gold if stock prices once again slide toward their lows.

I am still cautious about allocating to gold mining stocks because of their much higher volatility. I am not surprised that GDX is outperforming GLD year-to-date because it started the year from a much more oversold level. Many of the underlying gold stocks that reside in GDX are reporting earnings this week which could lead to additional bouts of quick price moves in either direction. Gold mining stocks are more suitable for aggressive investors that are comfortable with larger price fluctuations.

One additional correlation that is worth noting is that silver prices, which are tracked by the iShares Silver Trust (NYSEARCA:SLV), have lagged gold prices so far this year. SLV has gained 2.99% year-to-date through February 7. Typically the spot price of silver tends to be more volatile than gold as well, which may lead to a burst of strength if precious metals continue to break out.

If you do decide to dip a toe into precious metals, I would do so with a risk management mindset that takes into account the prior lows that were established at the end of last year. That is a natural exit point if this rally stalls and prices begin to falter. My final word of caution is to start small and average into any new positions so that you can take advantage of any pullbacks to add to your holdings.

Read more from David Fabian, Managing Partner at FMD Capital Management:

5 Best Bond Funds To Guard Your Nest Egg

Why The Market Doesn't Care Where You Think It Should Go

Fine Tuning Your ETF Income Portfolio For 2014


Twitter: @fabiancapital
No positions in stocks mentioned.