Brad Zigler: Gold Miners: A Bearish Hedge For Chickens

January 13, 2011

Weakness in gold miners got you nervous? Relax—the options market offers insurance for your investment.


You might have noticed that gold's upward momentum has been blunted recently. Last month, two attempts to take out the November high failed, leaving prices languishing.

For holders of gold mining stocks, times are even tougher, especially the early-stage companies populating the Market Vectors Junior Gold Miners ETF (NYSE Arca: GDXJ). The GDXJ portfolio gained 54.7 percent in 2010, compared to bullion's 29.8 percent rise, but now mining stocks are falling at twice gold's rate of descent.

The relative strength of junior miners, along with that of the established producers as represented by the Market Vectors Gold Miners ETF (NYSE Arca: GDX), peaked in early December:


Mining Stocks' Relative Strength Vs. Gold

Mining Stocks' Relative Strength Vs. Gold


The miners' weakness has some investors, especially latecomers, wondering how much downside is left in the current market. With GDXJ now trading at the $38 level, down from its peak near $45, serious damage could be wrought if market momentum takes the fund below the $35 level:


Market Vectors Junior Gold Miners


The present weakness could be temporary—a pause before another leg up (for a possible scenario after that leg, see "Is Gold Nearing A Bubble?"). Or it could be the vanguard of a secular change.

Worried bulls now ask whether it's time to bail from the market and wait to re-enter until the weakness subsides, or to instead just gut it out and stand pat.

But an alternative strategy—options—allows investors to remain in the market, thereby avoiding re-entry risk, while hedging against further damage. It's like taking out an insurance policy on your investment.

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