'Blood in the Streets' Gold Miner Play Could Pay Off Big

Haters gonna hate, politicians gonna lie, and gold bashers gonna bash. The third of these homespun truisms has never been more prevalent then of late, as nearly every pundit I've heard these days is ready to toss the metal, and miners, out like a red-headed stepchild.

Year to date, gold prices have admittedly been dismal. So far in 2013, SPDR Gold Trust (NYSE: GLD) is down more than 28%. Mining stocks have fared even worse.

Year to date, Market Vectors Gold Miners (NYSE: GDX) is down 54%. That's the worst performance in the sector since the widespread equity meltdown of 2008.

The chart below shows the fund trading well below both the short-term, 50-day moving average and the long-term, 200-day moving average. In fact, GDX now trades just slightly above multi-year lows.

GDX Chart

So, what's made gold and gold miners such an unappealing trade this year?

Well, first we need to understand that this year's selling came after a five-year bull run that was fueled in large part by the Federal Reserve and its easy money policies. A near-zero interest rate policy and massive quantitative easing via an $85-billion-per-month bond-buying scheme caused a lot of capital to maneuver into the safety and inflation trade that gold represents.

Yet, as the year got under way, the wind came out of gold's sails, as talk of Fed tapering and an improving economy caused a rotation out of gold and into high-flying equities.

Proof of the negative effect of tapering on gold can be seen recently. When the Fed finally announced that it would begin tapering next year at a proposed pace of $10 billion per month, the news sent gold and the miners down to multi-year lows, and both now are testing very long-term technical support levels.

But here's the thing -- if you are an intrepid investor looking to hit a home run in a very beaten-down sector, then I think there's none better right now than gold miners.

First off, there's the aforementioned technical picture. Yes, it's bearish here, but if we see gold miners hold support for a few weeks at current levels, then it could be the floor that the smart money has put on gold. It also could be the value at which the market looks at gold now that the taper decision has been made.

Second, the big-picture reason why gold and mining stocks went higher over the past few years is due to fear of inflation caused by all of the money printing that central banks around the globe have engaged in since the Great Recession.

While this inflation hasn't materialized yet, at least not in official metrics, there still are billions of dollars that remain on bank balance sheets that haven't yet made their way into the system. If that starts to happen in 2014, and an uptick in inflation begins, then gold and miners could easily catch a bid once again.

Finally, there is the "blood in the streets" reason to buy gold miners. This reference to the famous Baron Rothschild quote applies here, because to make the really big money in a trade you usually need to get into a trend before it ignites. In this case, before it re-ignites.

Doing so is, admittedly, a swing for the fences. In trying to hit a home run with gold miners, there's a good chance you could strike out. Yet, if you put a small amount of trading capital to work, and if you have a stop-loss in place, your downside is minimal in an ETF such as GDX. Meanwhile, the upside of another bull run in gold could let you participate in the contrarian glitter in the space.

Recommended Trade Setup:

-- Buy GDX above $22.90, just above the current 50-day moving average
-- Set stop-loss at $21.07
-- Set initial price target at $27.48 for a potential 20% gain in six months

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