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Morning Update

Yesterday the market sold off on news that Obama has been reelected and the announcement by Draghi that Germany’s economy is beginning to suffer from the European debt crisis. CNBC showed scenes of violent riots in Greece throughout the day, which also helped drive the market downward. The Greek riots were due to parliament’s austerity vote last night, which unsurprisingly passed. Today attention will be focused back on the US. Jobless claims this morning came in at 355K versus 370K expected and 363K last week. The US balance of trade was also released, coming in at -$41.5B versus -$45.4B expected and -$43.8B last month. The S&P 500 futures are modestly higher ahead of the market open though the better than expected data did not have a profound effect on them. Today we will be closely watching the S&P’s price action around 1402, which is the 100-day moving average, and 1380, which is the 200-day moving average. The market looks like it wants to test 1380, though it could test the 100-day moving average first to get some relief from yesterday’s sharp selloff.

One sector immune from yesterday’s sell off was the gold miners, who finished the day up 1.5% versus the SPY’s 2.3% slide. Physical gold was virtually unchanged in yesterday’s session though it jumped 1.8% on election Tuesday. The miner’s relative strength did not go unnoticed by option traders, who bought upside calls in GDX yesterday. The biggest trade of the day was the purchase of 50,000 Nov. 56 calls for $0.06, the purchase of 10,000 Nov. 52 calls for $0.56 and the purchase of 5,000 Nov. 50 puts for $0.91 with the ETF trading at 50.50. This is a bullish position that will profit from an explosive move upward in GDX over the next two weeks. The breakeven points to this trade are 52.68 (4.3% higher) on the upside and 43.18 (14.5% lower) on the downside. While this trade will make money on a large move lower, this spread was likely designed to be a bullish play that is hedged to reduce losses on the downside.

The reason for this bullishness on the gold mining sector is likely tied to Obama’s reelection, which has traders expecting Ben Bernanke to remain at the Fed and easy money policies to continue. Low interest rates and the potential for inflation down the road are supportive of higher gold prices, which in turn will benefit the gold miners. However, a rise in gold prices does not necessarily translate into an equal rise in GDX. Year to date gold is up 6.8% while GDX is down 5.1%. For this reason I like to trade gold itself, not the miners.

During the first four years of Obama’s presidency gold appreciated 136%, and high reelection means four more years of the same policies that drove gold higher. In the long run I am bullish on gold and expect to see it move higher. However, I trade gold using an economic model which suggests that current gold is trading at fair value. Therefore I am hesitant to buy deep out of the money options on gold or the gold miners, and would recommend anyone doing so to keep their risk controlled with tight hedges.

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