Gold Miners Tarnished

The price of gold has slipped some 12% since its all-time high over US$1,900 per ounce at the end of last August. Canada’s S&P/TSX Global Gold Index, however, has plummeted 31% in about the same period. You’d think there would have to be a closer correlation between the price of gold and the fortunes of gold miners, but no.

Trouble is, gold miners are businesses. They face costs and risks, both of which have been rising lately, putting pressure on profit margins and driving down valuations. This has become particularly noticeable since the beginning of 2012. Rising operating costs as a result of higher oil prices, higher wages, and lower ore grades have boosted cash costs for most miners. According to an RBC report, average cash costs for top tier miners in 2012 are likely to rise to US$618 per ounce from US$546 per ounce in 2011. And, says RBC, the risk is to the upside, meaning that costs could rise even more. That could put many gold miners in a tight spot for the rest of the year.

Options traders looking to leverage the possibility of continuing declines in the global gold sector might consider bearish trades in a broad index like the iShares S&P/TSX Global Gold Index (TSX: XGD, Friday’s close $19.31). Or even look at buying puts on the index as a way to hedge against further downside in gold stocks you may currently hold. With that in mind, look at buying the XGD July 19 puts at 75 cents.

For every rule, however, there is an exception. Speculative traders looking for a contrarian position might consider bullish trades in Agnico-Eagle Mines Ltd. (TSX: AEM, Fridays close: $38.70), which just reported first quarter earnings per share of $0.46, up from $0.26 a year earlier. The company reported it produced more gold in the first quarter (254,955 ounces) than in the first quarter of 2011
(252,362 ounces). Cash cost rose to $594 per ounce, up from $531. For all of 2012, the company expects to produce between 875,000 and 950,000 ounces of the yellow metal, at a cash cost of between $690 and $750 per ounce.

The company is coming off a bad year in 2011, having shut down its Goldex mine in Val D’Or, Quebec, owing to flooding and unstable rock formations. Share price was beaten down accordingly (down -46% since last September), but with mining and exploration operations in Canada, the U.S., Finland, and Mexico ramping up, 2012 could see an upside surprise for Agnico-Eagle, one that nimble options traders might turn to their advantage.

With his trade I would look at writing short-term at-the-money puts, specifically selling the AEM June 40 puts at $2.40 per share or better.