Investing in precious metal mining stocks can be a volatile business. You can minimize risk by buying baskets of these equities through popular ETFs like GDX and GDXJ. There’s nothing wrong with that.

I think, however, that we can do better.

One of the great advantages we have as individual investors is our agility. We don’t need to run with the herd. We don’t answer to anyone but ourselves. We can blaze our own trails … with just a little bit of work.

Today I’m going to show you how you can make volatility your friend and put together your own little basket of gold mining stocks.

I’ll be using our proprietary Volatility Quotient metric (VQ%) to compare the volatility between different mining stocks. VQ% is a metric which tells us how much we should expect a stock to move up or down over the course of a year or more just because of the noise or volatility in the stock.

Even in GDX, the more conservative of the precious metal mining ETFs, we can find very high volatility stocks. Here are a few of the most volatile components of GDX:

  • Tahoe Resources (NYSE: TAHO): VQ = 58.8%
  • SEMAFO, Inc. (Toronto: SMF): VQ = 58.1%
  • IAMGOLD Corp. (NYSE: IAG): VQ = 57.9%
  • Detour Gold Corp (Toronto: DGC): VQ = 54.8%
  • Alamos Gold, Inc. (NYSE: AGI): VQ = 54.1%

These are very volatile stocks. To invest in any of the above stocks we would need to be prepared for a drop of over 50% in the price of the stock as part of the normal course of business! Those are stomach churning levels of volatility.

These levels of volatility, however, are only so stark when you’re looking at the volatility of individual gold mining stocks. When you look at the volatility of a basket of gold mining stocks – like GDX – the volatility is a lot less. The current VQ on GDX is 39.2%. That’s still pretty high but it’s a lot less than a VQ north of 50%!

What I want to share with you today is that you don’t need a basket of 40 gold mining stocks (that’s how many stocks are in GDX) to lower your overall volatility. Even as few as 2 gold mining stocks can dramatically lower your volatility while not compromising your returns.

One of the lower volatility stocks in the GDX family of gold miners is Randgold Resources (NasdaqGS: GOLD). The current VQ on GOLD is only 31.9%. That’s pretty low for this sector. Here’s a chart of the past 3+ years on GOLD:

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On the other hand, we saw that one of the most volatile stocks in GDX was Tahoe Resources (NYSE: TAHO) with a stratospheric VQ of 58.9%. I’ve added TAHO to the chart below.

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Finally, I’ve added a third line (in green) to the chart below. This new line represents the combined performance of an equal weighted portfolio of both GOLD and TAHO.

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Now I know that everyone looking at the above chart is likely to say, “I’d rather have just bought TAHO!” Not so fast.

Look at what happened to TAHO from January 2013 through June 2013. It went from being up nearly 25% to being down over 75%!

Just imagine yourself having been invested in this stock. Initially (in January 2013) you’re saying, “I nailed this trade … in just a couple of months I’m up 25%.”

Then, all of a sudden your tidy little profit in TAHO is underwater … and under more water … and under more water. That’s a lot for any investor to stomach. Most investors would have drowned.

Combining both GOLD and TAHO into a single investment, however, would have had much more moderate volatility. The combined VQ of GOLD and TAHO is currently 43%. That’s a LOT less than 58.8% for TAHO.

Your drawdown in the combined position peaked at 50%, even at the worst point of the trade. Today you’re sitting on a handsome profit of 75%. Yes, it’s less than the 150% profit of TAHO alone but again, you have to ask yourself if you could have survived the volatility of TAHO alone. Would you have even still been in the trade?

So much of successful investing is about staying in the game. Thinking about your investments in combinations of stocks can be a very powerful way to reduce your risk, stay in the game and capture the longer term profits that the markets provide to the patient.

To patient profits,

Richard_Signature
Richard M. Smith, PhD
CEO & Founder, TradeStops