Gold Mining Stocks Poised for Further Gains: An Investment Opportunity Analysis

Gold Mining Stocks: Promising Opportunities and Potential Risks

While gold prices have retreated slightly from their highs reached nearly a month ago, close to $4,400/ounce, they are currently starting to rebound. Analysis from 22V Research indicates this rebound presents a favorable opportunity for gold mining stocks – considered a leveraged play on gold.

For decades, gold has exhibited an inverse correlation with the stock market, but with growing concerns about dollar depreciation and strong demand for the precious metal from central banks across various nations, the correlation between gold and the stock market has turned positive.

"For a while, gold trading has been behaving almost like a meme stock," Jeffrey Jacobson, Head of Derivatives Strategy at 22V Research, stated in a phone interview.

Correlation Between S&P 500 Index and Spot Gold Prices

According to Jacobson, the VanEck Gold Miners ETF (ticker GDX) typically experiences twice the volatility of gold prices themselves. The fund's year-to-date return has exceeded 125%. In comparison, the SPDR Gold Shares ETF's (ticker GLD) 57% rise over the same period is noteworthy but still falls significantly short.

This week, the U.S. Congress is pushing to end the longest government shutdown in history, leading to a rise in the stock market and a shift in investor sentiment towards optimism regarding gold. Some strategists believe that last month's pullback in gold prices from record highs was more a result of profit-taking than the end of the bull market.

"The selling wave has passed, and gold is poised to continue rising, moving towards a new series of record highs," Tim Hayes, Chief Global Strategist at Ned Davis Research, wrote in a report on Tuesday.

Jacobson advocates using gold ETF derivatives to bet on a further rebound in gold prices, stating in a report on November 10th that the current time is "the best time to consider adding call option structures, betting on a rebound in gold prices."

In fact, later that day, a trader spent over $35 million to establish an options position – which would profit if the GLD price closes above $390 in mid-December. This trader bought a so-called "call option spread," a strategy that can benefit from a slight increase in the fund in the coming weeks, but will not benefit from excess returns if gold prices exceed record levels.

However, Jacobson believes that GDX options, which track gold mining stocks, have greater investment value compared to GLD options. He points out that according to the valuation metric “skew,” investors are not as keen on call options for mining stocks as they are on call options for gold itself.

Precious Metals Call Option Premium Exceeds Mining Companies

He says, "If you believe that gold prices will rise, that gold mining stocks will regain their leading position, and that the call option skew for GDX is currently less than 2x, then this is also a reason to own GDX call options or a call option spread to bet on its continued rise."

On an individual stock level, gold mining companies such as Newmont Corp. (ticker NEM), Agnico Eagle Mines Ltd. (ticker AEM), and Barrick Gold Corp. (ticker GOLD), have seen gains this year of approximately twice that of spot gold. Even in the face of challenges for Barrick, such as the departure of its CEO, ongoing issues in its Mali operations, and third-quarter revenues that came in below expectations, these factors have not deterred investors – the company's stock price has risen by over 130% since the beginning of the year.

Analyst forecasts compiled by Bloomberg suggest that gold production for these three companies is expected to decline this year, but thanks to rising gold prices, revenues are expected to achieve double-digit growth, and adjusted earnings per share are projected to grow by at least 79% year-on-year.

Gold Mining Stocks Outperform S&P 500 Index Year-to-Date

Of course, risks must be considered when looking at gold mining stocks. GDX is a high-volatility tool for investors to participate in the so-called "dollar depreciation trade" (where rising gold prices are due to a structural withdrawal of funds from dollar assets).

Due to the extremely wide range of potential outcomes, implied volatility is high – this serves as a warning from the options market: that an ETF that has doubled in less than a year could easily experience a significant correction.

"You should expect these stocks to experience significant volatility," Dean Curnutt, CEO of brokerage and research firm Macro Risk Advisors, said in an interview. He added, "High implied volatility indicates that the range of volatility in potential outcomes is extremely wide."