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Despite Wednesday's Fed minutes -- where we learned that Fed Chair Janet Yellen sees a more aggressive path toward short-term interest rate hikes -- gold prices held firm. As we've seen in recent months, an interest rate increase, whether real or anticipated, boosted the value of the U.S. dollar. That, in turn, depressed gold prices and gold stocks, thanks to the typically inverse relationship between the yellow metal and the greenback.
Right now, the charts show a rather encouraging condition for gold stocks, although the outlook for gold itself isn't as rosy. In particular, the VanEck Vectors Gold Miners ETF (NYSE: GDX) just scored a technical breakout, which could lead to several weeks of further gains.
To be sure, this could be a controversial view considering that the sentiment on gold and related investments is quite low. With inflation holding at low levels and the long-term trend in interest rates still officially down, owning gold for its traditional hedging qualities seems to be out of touch with reality.
Still, the market is telling us something with the setup we now see. After testing the falling trendline drawn from last year's high water mark, GDX has broken chart resistance at $22.25 that goes back several years. The ETF rose as high as $23.35 on Thursday, and if it's able to hold that level, it will be proof that the mood has changed for GDX.
In technical analysis, price levels gain importance when they serve as turning points, aka, support and resistance. The longer these levels are in play and the more times the market actually turns at them, the stronger they become. Why? Because investors, whether they know it explicitly or not, see these levels as either cheap, in the case of support, or expensive, in the case of resistance.
The corollary is that, when the mood changes, the market breaches these strong levels. For resistance, what was once thought to be expensive is now considered cheap. The market rallies from there, just like we're seeing with GDX now.
There are other technical reasons supporting a continued breakout from here. For starters, the ETF scored a bearish reversal at resistance just last week. It seemed that the bears got quite active when the $22.25 level was close, causing a small sell-off. However, the bulls were not deterred, and prices managed to rise, eventually leading to today's breakout. That suggests demand is still firm.
I'd be happy to see volume expand as GDX breaks out, but that isn't crucial to our trade. The fact that so many people are bearish on gold and gold stocks sets up a contrarian condition where bears will be forced to cover their short positions, which will add to demand.
As a bonus, the breakout through the trendline and resistance has also pushed the ETF above its 50-day moving average. I don't believe averages serve as trade triggers on their own, but the more evidence we have of a breakout, the better.
I expect the rally to stall at the next resistance level of roughly $25.80, but that still represents an 11% gain in short order. We can re-evaluate the trade once it gets there to see if the technicals -- such as momentum and volume -- warrant keeping it going. Also, we have to see if the dollar returns to its winning ways after being on hold for weeks.
But let's cross that bridge when we get to it. For now, an 11% gain in four weeks' time is a good deal.
Recommended Trade Setup:
-- Buy GDX at market
-- Set stop-loss at $22.25
-- Set initial price target at $25.80 for a potential 11.2% gain in four weeks
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