Gold Miner’s Day in the Sun?

Gold, everyone’s favorite precious metal, ended the week down from its record high of US$1,917.90 per ounce last Tuesday. December futures contracts closed the week at US$1,797.30 per ounce, down 5% in the past week, as gold posted its first weekly loss in eight weeks. In after-hours trading, though, it had climbed back up to US$1,823. So while there were predictions aplenty that gold was ready for a serious blowoff, the ultimate store of value continues to defy expectations.

I touched on the gold story back in July, when we suggested that gold miners had quite some catching up to do. We suggested bullish positions in a broader gold index fund like the iShares S&P/TSX Global Gold Index Fund (TSX: XGD, recent price $26.05) or in individual players like Goldcorp Inc. (TSX: G, $50.98).

Despite that short-term volatility through the July, it appears as if the gold mining story is on track to play out as expected. Mining companies look set for something of a rally in the final months of the year, as higher production through the summer, with the record price of gold, finally catches up with earnings. Companies like Barrick Gold Corp. (TSX: ABX, $50.06), with a particularly low price/cash flow ratio of 9, are prime candidates for a pop.

Another factor weighing in favor of ABX is the fact that it no longer hedges its gold production. Meaning that any pop in gold goes directly to their bottom line. At this stage, you have to believe that the company will report some pretty stellar numbers in the latter part of the year. And, since the options on ABX are quite liquid, traders can move in and out of positions with relative ease.

With that in mind, more aggressive traders might look to buy ABX January 50 calls at $4.20 or better. Look for an opportunity over the next few weeks to double up on this trade. If we get a further pop in gold, you would sell half your position if the calls reach $8.00 per share.

If you are a more conservative trader, selling cash secured puts would be a strategy to consider. In this case, you would write (i.e. sell) the ABX October 52 puts at $3.65 per share. If you are securing this position with “cash,” you would be required to hold sufficient cash equivalents to purchase the shares at $52 per share until the January expiration. Which is to say, you would deposit $5,200 (representing the strike price of one January 52 put contract) less the $365 you would receive from the sale of the put. If the stock is above $52 at the January expiration, the puts will expire worthless and you pocket the premium. That by the way, is your maximum profit on this trade.