Pair Trade: Buying Gold ETF, Shorting the 20-Year Treasury

Includes: AUY, GLD, KGC, TBT
by: Sean Farhy
It may be time to start to rethink buying back into gold and gold stocks. The recent events of past few days make me think that we could see gold soar to $2,200 an ounce by the end of the year. Gold could go even higher depending on the dollar.
This week alone we have heard Ben Bernanke and friends talk about and then dismiss another quantitative easing, or QE III. Given the fact that we are coming into an election year, my guess is that QE III is not completely off the table. If QE III does happen (which I think it will) it should result in short term deflationary pressures as the Federal Reserve buys back U.S. Treasuries. These buybacks, or the monetization of U.S. debt, should help stabilize bond prices only temporarily, as one can only kick the can down the road for so long. It’s the mid to long term that worries me most.
Gold and gold stocks may be a prudent buy because of the U.S. and global debt crisis. Here in the U.S. there is the uncertainty whether or not the President and Congress can come to some agreement on the debt limit. The August deadline will be upon us in weeks and an accord on this issue is becoming less and less likely. Moody’s historic debt downgrade watch of the United States has opened the flood gates. I expect more events like this to come as it is no longer taboo to “downgrade” the country that found capitalism and democracy. (While I was writing this article the S&P put the U.S. on downgrade watch as well.)
The long/short trade that may make the most sense is to buy GLD and short the 20-Year Treasury by buying the corresponding inverse exchange traded fund, TBT. Be aware that the TBT side of the trade is a (2:1) leveraged fund while the GLD is not.
The two gold miners that I feel have the most upside are Kinross Gold (NYSE:KGC) and Yamana (NYSE:AUY). Kinross and Yamana are both Canadian companies, which could fare rather well in the event of a U.S. dollar crisis as investors move out of the U.S. currency and into the Loonie.
Kinross’ 2.73 PEG ratio is one of the higher ones in the gold and precious metals industry, which is 2.5 times higher than the industry average. Also making Kinross attractive is its P/E of 18, about 10% less than its peers. Yamana Gold is the smaller of the two companies and has a forward P/E of 11 times PEG growth of 1.67 times. All of this sets up for the potential for Kinross at $25 and Yamana hitting $23 within the upcoming 12 months.
For those looking for more diversification in the gold and precious metal arena, take a look at the Market Vectors Gold Miners ETF (NYSEARCA:GDX).
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.