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Stock Article: Mining for Leads
Written by article default Tuesday, 08 June 2010 10:29
With all of the market volatility lately, oil and gold have been heavily talked about and are an excellent opportunity for traders and investors. As a stock trader, you can play these commodities without having to open a futures account. ETF's such as GLD and USO are tradable in an equity account. There are even ultra commodity ETF's like UGL (Ultra Gold), GLL (Ultra Short Gold), UCO (Ultra Long Oil) and SCO (Ultra Short Oil) that use leverage to enhance returns when trading. You must be careful when using the Pro Shares Ultra ETF's as their light volume and leveraged nature also increases risk.Now to enhance our odds of making correct decisions on the commodities, traders should realize that the commodity price will often follow the prices of the stocks of the companies that mine or produce that same commodity. If you are trading gold, it helps to watch the prices of gold miners such as Barrick (ABX), Goldcorp (GG), or Newmont (NEM) to get a clue as to the future direction of the yellow metal. You can even use the gold mining ETF, GDX or the oil services HOLDRs, OIH as a leading indicator for black gold.
Comparing Barrick Gold Corporation and GLD, there is approximately an 85% positive correlation of the price movement between the two. Looking at the chart below, you can see that there are times when Barrick's chart will warn of a trend reversal where GLD does not. Watching the price of the miner helps to warn when stops need to be tightened or entries or exits timed.
Figure 1
The same technique can be applied to intraday charts. In the following chart, I have compared the mining ETF, GDX with GLD on a 5-minute time frame. The gap on the 26th occurred after a rise in price, which is identified as an amateur gap in the Extended Learning Track program. These gaps tend to fill during the trading day. Just before 11am, GLD was showing topping tails indicating selling pressure and a possible end of the morning bullish run. At 10:55, GDX broke the uptrend with a large red candle, five minutes before GLD formed a red candle that started the drop in price. Had you been watching the mining stocks or ETF's, you could have exited a long position and profited from the downward move as well. Once the gap on GDX was filled at the end of the day, a trader could have expected some support on both GDX and GLD. The gap up the following day in GDX drug gold higher, even though it had gapped down.
Figure 2
The oil ETF, USO, will typically follow the oil service ETF. Sometimes it is just a confirmation, other times it can be led by enough time for you to react. The daily chart of OIH demonstrates the predictive power of the services ETF. Nearly all of the turndowns in the price of oil (USO) were predicted by drops in the OIH ETF. Additionally, USO rallied after OIH bounced from a support level.
Figure 3
This technique will work most of the time on all commodities and on all time frames. If you are not sure which stocks make up the mining companies, you can look up the index or the ETF holdings on Yahoo Finance. Just type in the name of the commodity into the search box and select, "Show all Results." You can then select ETF's.
Figure 4
Look for the leaders, as that will give you some indication as to how the commodities should move. Until next time, safe trading!