Pairs trading is a market-neutral strategy that matches a long position in one security with a short position in a second highly correlated security. The strategy’s profit is derived from the difference in price change between the two instruments, rather than from the direction in which each position moves. It is possible for pair traders to profit during a variety of market conditions, including periods when the market goes up, down or sideways, and during periods of either low or high volatility.
Pair trading the VanEck Vectors Gold Miners ETF (Symbol: GDX) against the SPDR Gold Shares ETF (Symbol: GLD) presents an interesting challenge as the volatility of the two ETFs can be radically different at times and gold can trend for long periods of time, making reversion to mean strategies difficult to implement.
The Equity Analytx US Industry Aggregates database provides the best set of indicators for deciding when to go long GDX/short GLD or vice versa. This is accomplished by associating the gold sector aggregate indicators with the equities held by the Gold Miners ETF. When the aggregate indicators suggest that the gold stock value fundamentals are good, GDX should be held long/GLD short. When the fundamentals do not appear to be so good, GDX should be shorted/GLD held long.
The following two sections illustrate how the US Industry Aggregate indicators can be used. Scatter plots are provided which show profit (%) 1 year out versus indicator assuming equal $ amount of GLD (long) and GDX (short). The first section uses aggregate fundamentals from within the gold sector itself. The second section provides inter-sector (or intermarket) indicators that also demonstrate future profit potential. It is left to the reader to decide whether these relationships are causal or coincidental.
This section demonstrates how aggregate indicators from other industries can be used to predict future direction of the GDX-GLD pair trade.