With gold prices looking strong amid an uncertain macroeconomic environment, adding long exposure to Direxion Daily Gold Miners Bull 3X ETF (NYSEARCA:NUGT) could be an attractive play going forward. Gold prices have held up well the last few months amid rising interest rates and increasing volatility in equity markets. Inflation pressures could force global central banks to tighten policy quicker than expected in coming months. NUGT's leverage factor and liquidity make it the perfect play to gain long exposure to a potential rise in gold prices over coming months.
Gold
Gold prices look strong amid an uncertain financial market environment. Over the last few weeks, rising inflation pressures led interest rates quickly higher, which spooked equity market investors. The constant as this was occurring was gold prices staying within a $1300-$1360 price consolidation.
Gold looks interesting as a potential hedge on both inflation pressures and equity market volatility. It is one of the only asset classes over the last 5-years to not be within striking distance of record high levels. This relative under-performance could signal that a reversal in trend across equities and bonds may lead to inflows into the precious metal.
Source: Trading View
Interest Rates
Since July 2016, the 10-year Treasury yield has roughly doubled. Although interest rates remain at historically low levels, the pace of increase spooked investors in riskier assets. Global monetary tightening, as well as the emergence of inflation pressures could keep support under interest rates going forward, which may cause equity investors to reprice their holdings lower.
With short-dated interest rates now above many stock dividend yields, investors can generate yield on a relatively safer asset class, leading to equity market selling pressure, especially across interest rate sensitive sectors, such as consumer staples and utilities. Rising interest rates are something to watch, especially as inflation pressures potentially increase in coming months.
Equity Market Volatility
As was stated above, equity markets have come under pressure in recent weeks, leading volatility gauges to spike higher. From mid-2016 through early 2018, the S&P 500 Volatility Gauge [VIX], held below 20. Now however, the indicator sits right at 20, spiking higher on days when selling pressure enters the market. With equity investors on edge more than at any point over the last two years, finding the appropriate hedge is needed. Gold and gold mining stocks tend to rise during periods of prolonged equity market volatility. Considering this, NUGT, may be the best way to hedge your portfolio currently should the portfolio lack precious metal exposure.
The Trade: NUGT
The appropriate trade based on the analysis above is to add NUGT to your portfolio as a low, to negatively correlating asset class. I like NUGT for a number of reasons. For one, it is a 3x leveraged product. This means that you don't need a large position to generate strong returns. Additionally, if you have the appropriate stop-loss points, then you can heavily skew the risk/reward ratio in your favor.
Another attractive feature to NUGT is that it is a liquid, highly traded security. The ETF has over $1B in assets, as well as an average daily trading volume of nearly 7M shares. Considering these two factors, it allows you to both enter and exit as you please, while setting appropriate price levels. If gold breaks out above $1360, gold miners should similarly jump higher as their margins stand to gain from higher gold prices. I will trade NUGT off of gold prices themselves, setting a stop-loss level with gold prices just below the potential $1360 breakout level.
Source: Trading View
Additionally, you can go out and purchase LEAP options on NUGT as it has a very liquid market across all of its options issues. For example, you can purchase exposure to January 2019 $24 strike LEAPS for roughly $6.5. Although the implied volatility is elevated, you have to remember that this is an option on a triple leveraged product. Also keep in mind that it is possible to lose your full options premium, so weight the position appropriately.
Source: Think or Swim
Conclusion
I am potentially buying shares of NUGT as a way to hedge against both rising interest rates and equity market volatility. Inflation concerns have sparked rising interest rates in recent weeks, ultimately spooking equity investors and pushing down stock indices. Gold prices have largely stayed within its trading range, signaling investors could bid the precious metal higher if the current environment continues. I am looking to buy both stock and options in NUGT due to its leverage and liquidity. Should gold prices breakout higher above $1360, I will add positions to NUGT, with a stop-loss point below the $1360 breakout level in the metal.
