GDX: Assets & Cash-Flow In Place (NYSEARCA:GDX)

El mineral de oro puro encontrado en la mina está en manos de los hombres.

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Intro

If we pull up a long-term chart of VanEck Gold Miners ETF (NYSEARCA:GDX), we can see that shares look very oversold and are trading very close to long-term support. We are expecting a bounce here soon enough for the following reasons. First is the fact that the majority of large caps in this space will continue to generate strong cash-flow irrespective of the drop in the price of gold over the past two months. We have alluded to this in previous commentary when we stated that investors should follow the money trends when making investment decisions. Dividend growth rates for example on the back of strong earnings and cash-flow growth in the gold mining space over the past three years or so have easily outperformed other sectors. GDX has incorporated these sectors’ growth rates into its own dividend, which continues to grow meaningfully. We believe these elevated growth rates will continue because many of the large-cap names in GDX have very low all-in sustaining costs which means meaningful free-cash-flow generation can still take place well below the current prevailing gold price which comes in at $1,826 per ounce.

Investing in the gold mining space is a leveraged play on gold and this can be clearly seen from the fact that the yellow metal is only down approximately 12% from its 2022 high whereas GDX is down over 30% from its April high of well over $40 a share. Many individual mining companies have lost well over 30% which again demonstrates that GDX is for the gold mining investor who wants leverage in this space but not as much volatility as individual mining companies present. Furthermore, the fund’s liquidity both in its shares as well as its options brings extra advantages to the table for the gold mining investor. Here is how we are playing our long position in GDX going forward.

GDX Long-Term Support

GDX Technical Chart (Stockcharts.com)

As mentioned, investing in an ETF like GDX whose asset flows continue to gain traction reduces risk because of the practical impossibility that the fund could go to zero. Another way (due to the fund’s strong liquidity), we can reduce risk is by buying deep-in-the-money LEAPs (Long-term Equity Anticipation.) which are long-dated call options that expire well into the future, sometimes up to two years at a time. We invariably buy these contracts with a very high delta (Usually 90+ which means their movement mimics stock-movement all things remaining equal) which means they have a minimum time-decay element (Theta).

Now, in some circles, LEAPs get a bad name because of their leveraged nature. We get this. They are options, and the value of an option decays aggressively the further it goes out of the money. Experienced LEAP investors though never let this happen. In fact, for GDX for us at present, we expect the mining sector to remain in a bull market for many years to come. Suffice it to say, we view those GDX LEAPs are assets where our preferred holding period is forever. Here is how we ensure they generate cash flow over a consistent basis.

Step 1 – Get Your Inventory In Order

Buy LEAPs at a 90 delta or higher in a far-out expiration cycle. The most important scenario when these LEAPs absolutely must be sold is when they start to lose delta, which means they are now trading out of the money. So basically, anytime from around 6 months before expiration, these LEAPs must be sold and then accompanying further out LEAPs with once more a 90+ delta must be bought to replace them. A loss will have to be taken upfront but if one was holding GDX shares, for example, the “paper loss” would be much more due to the basket of shares continuing to have the same delta whereas the LEAPs lose delta the more they go out of the money. Despite rolling for a loss, the key is to always have our inventory in place.

The only other scenario we may opt to sell would be if the price of GDX were to spike, (which would make the LEAPS go even deeper in the money), the liquidity of those contracts may in fact deteriorate. Seeing if indeed this was taking place, we may roll up the LEAPs to more liquid strike prices.

Step 2 – Turn On Your Cash-Flow Machine

Having our inventory in place, we now aggressively sell short-dated out-of-the-money GDX options against these long-term positions. Being sellers in this instance, we want theta to work for us aggressively, which is why we aim to sell short-dated options. With our short-dated options, we remain very nimble. This means, depending on where GDX is trading, we adjust our short options to compensate. Suffice it to say, our strategy here is to remain out of the money and to consistently collect credits when rolling options from one cycle to another. Just remember, as long as you do step 1 correctly by having assets in place forever, you can consistently sell near-dated options to bring in consistent cash-flow also forever.

Conclusion

The long-term diagonal spread in GDX is an excellent strategy for the cash-flow-orientated investor who wants to put up much less capital than a traditional covered call. Just keep on rolling those shorter-dated options for a credit to ensure cost basis is being consistently reduced in the position over time. We look forward to continued coverage.

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