Gold Slip Slidin’ Away?

Gold has been steadily sliding from its January 3rd peak of peak of US$1,422.60 per ounce. With fears of more stringent efforts by China to cool its red-hot economy, commodity prices have retreated significantly. Not to mention the steadily improving economic recovery in the U.S. and Europe and some stability in the US dollar. Taken together, gold has fallen from grace. Or more likely is going through a reasonable correction.

I’m reminded of comments from Dennis Gartman of the Gartman Letter. He is bullish on gold and thinks the current decline is simply a minor setback. As he said, if gold was a stock trading at US $14.22, a decline to the US $13.42 level would not be anything to worry about. Some might even say it is simply noise. But when talking about gold, a US $80 decline becomes significant, though on a percentage basis, we are talking the same thing.

Gold’s sell-off has had a more dramatic effect on companies like Barrick Gold (TSX: ABX, Friday’s close $46.33). Not surprising when you consider that Barrick is a low cost producer with an un-hedged inventory. That effectively leverages its value to the price of bullion as Barrick typically outperforms when bullion prices are rising and underperforms when prices are declining.

Look at a relative performance of Barrick versus gold and that is exactly what has happened since the beginning of December 2010. Barrick outperformed bullikon until the first week of December 2010, at which time it began falling much more dramatically than the price of bullion. Interestingly, by the third week of January 2011, the year-over-year return on Barrick, almost exactly matches the performance of bullion.

Fundamentally, of course, gold mining companies have different metrics, and those who trade gold companies, have different motivations. Traders see bullion as crisis insurance and tend to value it based on sentiment. Gold stocks tend to trade on their earnings potential and dividend outlook.

If you buy into Gartman’s scenario then Barrick becomes a way to leverage an upswing in gold prices. And with option premiums at such low levels – at least relative to historical norms for gold mining companies – buying Barrick calls would be the easiest and best way to play a rebound in gold. If you like gold’s longer term potential, take a look at the Barrick July 48 calls at $3.45.