While gold prices had been steadily ticking higher in anticipation of the Brexit vote, the surprise decision - which led to a selloff in every major equity index and the resignation of Prime Minister David Cameron - drove gold prices to the highest levels seen in over two years (see the SPDR Gold Trust ETF (NYSEARCA:GLD)). The yellow metal continued higher on Monday, as major U.S. indexes continued to fall - the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) is down over 4% in the last two days, as of this writing. While some pundits are encouraging investors to wait on the sidelines, Brexit represents a significant opportunity to capitalize on important moves in two asset classes.
Brexit Should Help Gold Shine
While the case for gold has been improving on multiple fronts throughout the year, the withdrawal of the U.K. from the EU has already proved a near-term catalyst. ETFs of both gold itself and gold miners - see the VanEck Vectors Gold Miners ETF (NYSEARCA:GDX) - are up nicely since the news broke. With the Fed expected to begin raising rates at some point late this summer, gold-backed investments should be considered more attractive.
Additionally, plans to expand profitability rather than production from the miners - as recently reported by VanEck - should serve as an additional upward force on the yellow metal. The firm went on to say that it believes an important inflection point has been reached and that the market appears to be entering a new bull market.
Brexit Equity Turmoil Will Continue
Despite the immediate selloff that has been experienced by the equity markets, there is additional downside to come. Without discounting the immediate results seen in stock prices, the move is hardly indicative of the turmoil that Brexit may cause. The move lower takes the SPY below recent support levels, not just giving back very near-term gains as Jim Cramer suggested when recommending a sidelines approach. Even with that in mind, however, the next meaningful support level is around 190.
If these levels are tested, it represents a 10% dip in the index, which could trigger additional selling. The upcoming election this fall has the potential to prove one of the more polarizing from Wall Street's perspective in recent memory. The overall message is that Brexit and other factors represent significant uncertainty and a reason to be short equities for the next several months.
The Pairs Framework
While the typical argument for a pairs trade - long one stock and similarly short another related stock - is to mitigate risk, and give the trade a meaningful element of market neutrality, this trade is likely a doubling down on similar theses. For at least the next several months, stocks and gold are likely to be impacted by some of the same forces, and as a result, to move in opposite directions.
The recommended trade of buying gold and selling stocks will likely be successful - or not - on both sides of the trade at the same time. As a result, this trade should be appropriately sized for one's individual level of risk tolerance. The larger opportunity for the long-term exists here in gold - gold's position is more clear - but going long GLD and short SPY is expected be successful in the wake of Brexit.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.