Bloomberg News
 
 
The gold trade is showing signs of weakness. Two key gold mining exchange-traded funds fell 7% Wednesday -- at a time when circumstances indicate their values should rise or at least stay steady.

The declines in the VanEck Vectors Gold Miners ETF and the more volatile VanEck Junior Gold Miners ETF may signal that some investors are rearranging portfolio allocations ahead of an event-heavy central bank calendar.
 
The moves coincide with strength in beaten-down, rate-sensitive sectors, including the financials, which have been trending higher.

In totality, the multi-sector trading action is a potential indicator that some investors are preparing for U.S. interest rates to rise by year’s end.

Those two exchange-traded funds are up 122%, and 160%, respectively, so far this year, but profit-taking tends to be less disruptive than what happened on Wednesday.

The VanEck funds traded Wednesday in a fury that often coincides with institutional investor groupthink. When word spreads from one desk to another that a major fund is doing something, it often is acted upon as a leading indicator. It is an admittedly soft data point, but it is deeply rooted in the financial industry.
 
 
Though we advised investors in June to secure profits, locking in triple-digit gains and maintaining exposure with upside calls, it is hard for many to give up great trades. They would rather maintain a bullish position -- especially when it is outperforming everything else in the market -- until it actually weakens. Then, and only then, do they make a move. Investors who were rattled by Wednesday trading can simply buy puts to hedge.

With the VanEck Gold Miners trading recently at $27.68, investors can buy the December $23 put for 73 cents. If GDX drops to $20, the put is worth $3.
 
Wednesday’s volatility is an indication of how violent this ETF can behave in a downspin. Rather than “spreading” to create a trading range, it is arguably better to pay full-freight to hedge. This simple trade now seems best. Who knows if the fund will try to retest the bottom of its trading range.

The 52-week range is $12.40 to $31.79.
 
Investors concerned about the stability of the VanEck Junior Gold Miners should sell their positions and lock in the extraordinary gain. The liquidity in the options market seems to lack the robustness needed to effectively hedge.
 
Hedging after a sharp decline is like buying insurance during a fire. A fear premium has already lifted options prices, and investors will pay top-dollar to buy puts. But if you are concerned that the downside is just beginning, or that you need to lock in the bulk of your profits, the added friction is the cost of business.
 
In candor, interpreting trading flows is difficult. It is like palm reading, but it is one of the mainstays on Wall Street. To make the analysis more meaningful, you have to consider broader issues in other sectors. 
 
We know many institutional investors entered second-quarter earnings season by buying calls, and then shares, on beaten-down, high-growth stocks.
 
This led to a quiet rotation away from slow-growth, high-dividend sectors into sectors like technology and banking
 
The trades anticipated that corporate earnings would be better than expected and that economic growth would improve, thus securing profits in the stock and options market. That scenario mostly occurred, and it is not unreasonable to conclude that this is leading to a rearranging of portfolio allocations for reasons ranging from relative value to anticipating a rate hike. After all, constructive economic conditions are a prerequisite to a rate hike.
 
If the Federal Reserve raises rates, the gold sector trade is not as attractive as financial stocks. Banks make more money off higher rates.
 
An anti-rotation thesis can also be argued. It is hard to see the Fed significantly raising rates when the global economy is weak, but the event calendar represents risk to the gold thesis.
 
Even if the Fed does nothing at its next three meetings, the risk to gold is high. Bank governors can be counted upon to talk about how conditions favor a rate hike. Sell-side banks, so desperate for trading volumes, can be counted upon to gin-up rationales for event-driven trading. You can fade the near future, and let your profits ride in GDX and other areas of the gold sector. If you do, though, recognize that you are gambling, not investing, and definitely not trading.


STEVEN SEARS is the author of The Indomitable Investor: Why a Few Succeed in the Stock Market When Everyone Else Fails.