Question: What is it that we are trying to achieve?
Answer: Exposure to the gold bull market in order to generate a handsome return on our investments.
We are all aware that there are a number of vehicles available to us for this very purpose, including the acquisition of physical gold, investment funds, gold mining companies, options and/or futures trades.
We have long held the view that holding physical gold in your very own hands is the first step and you then have the outright ownership of gold and you are not subject to the vagaries of the third-party risk that comes with owning paper. If you are comfortable with owning paper and enjoy the ease at which you can move in and out the various funds that are available or the speed at which you can trade stocks, then that's fine, as it is your aversion to risk that needs to be satisfied.
Now, if you are keeping up with play you will have noticed the chorus of support for the mining sector lately. Some miners do indeed have excellent management teams in place, with good track records along with interesting prospects in relatively safe mining jurisdictions. They should also be generating a fair amount of cash, with gold prices trading around the $1,700.00/ounce (oz) level. Let's face it, if they are not making money at these levels you would need to ask why you need to own them at all. Then there is the question of what use will be made of this cash pile—another acquisition, an increase in the exploration budget maybe, or even paying their loyal investors a dividend. Some miners are involved in all of these activities, although it has to be said that the dividends are not yet attractive enough to entice an investor looking for a handsome return for taking such a risk. To get the returns that we would like, we tend to look to those miners who are unhedged, that is as a miner who does not forward sell the gold for today’s gold price, that will be produced later on.
However, having tracked the progress of this sector of the market closely we are not impressed. If you take a quick look at the chart of the unhedged miners, the HUI,* you will note that it has been in consolidation mode for some time now, and it did touch 500 in March 2009. Today it stands at 509.42, so unless you are an exceptional stock picker your money hasn't been working for you at all. We would like to see a serious breakout above the 600 level before we would be comfortable with acquiring any more stock.
The juniors are also being trumpeted as the place to be. However, many of the juniors do not have any ounces of gold in the ground as proven reserves, therefore why should they rise with gold prices? Junior explorers tend to rise on whether or not they have found gold, not in lockstep with the gold price.
As a suggestion for those of us who do want to maximize their returns from this precious metals bull, then a few carefully thought-out options trades could be a possible solution for us. This way we are exposed to any movement in gold prices, which in turn is magnified by the effect of the option. Do remember that loses are also magnified in the same way, so it's not a strategy for those who have an aversion to risk. On the other hand the quality stocks are not performing as anticipated and a non-producing junior stock is a shot in the dark, however, it's your hard earned cash and its your call.
You may be interested to see some of our past posts on this subject as we have wrestled with it and found it worrisome of late.
Are Gold Stocks Worth the Effort? (Aug. 15, 2010)
Are Stocks the Way to Play This Bull? (Feb. 27, 2010)
Gold: Are Juniors The Way To Go? (July 7, 2008)
*The HUI is The AMEX Gold BUGS (Basket of Unhedged Gold Stocks) Index represents a portfolio of 15 major gold mining companies. The index is designed to give investors significant exposure to near term movements in gold prices—by including companies that do not hedge their gold production beyond 1 1/2 years.
Bob Kirtley, SK Trading Options
To stay updated on our market commentary, which gold stocks we are buying and why, please subscribe to The Gold Prices Newsletter, completely free of charge. Simply click here and enter your email address.
Winners of the GoldDrivers Stock Picking Competition 2007
Disclaimer: www.gold-prices.biz or www.skoptionstrading.com makes no guarantee or warranty on the accuracy or completeness of the data provided. Nothing contained herein is intended or shall be deemed to be investment advice, implied or otherwise. This letter represents our views and replicates trades that we are making but nothing more than that. Always consult your registered adviser to assist you with your investments. We accept no liability for any loss arising from the use of the data contained on this letter. Options contain a high level or risk that may result in the loss of part or all invested capital and therefore are suitable for experienced and professional investors and traders only. Past performance is not a guide nor guarantee of future success.