Gold: Where’s the Glitter?

For gold aficionados, it has been a rough eighteen months. Even diehard doomsayers who see gold as crisis insurance have been asking; “where’s the glitter”?

From my perspective, I have never been a gold buff and have never believed it was reasonable to view gold as portfolio insurance. So, we are left with short-term trading opportunities among gold mining stocks where traders try to capture emotionally induced rallies interspersed with sharp sell-offs. Fear and greed play such an important role within this sector!

Because gold stocks consistently display above-average intraday volatility, they do make for interesting covered call candidates. A study I did in the 1990s examined the sale of short term at-the-money calls against a number of gold stocks. Over a ten year period, the covered call strategy produced two to four times the return when measured against a buy and hold strategy for the same stocks. Suggesting that writing covered calls on gold stocks was an excellent strategy to consistently produce alpha.

Seems counter-intuitive to gold buffs, who argue that gold has generated substantial returns since the turn of the century, outperforming most other sectors by a sizeable amount. At least that was the case until the past eighteen months.

In reality, most gold stocks – accepting that some stocks within this sector get taken out to the woodshed because of some unique non-systemic risks (i.e. Barrick Gold being a case in point) – tend to trade within a range and the options market does a decent job of predicting what range is reasonable.

Recent momentum has provided some decent rallies within this sector, which on the surface suggests that gold stocks may have seen their bottoms. Non-systemic risks aside!

If that is the case, then it may be a good time to consider a covered call or naked put strategy. Selling covered calls strategy as an income generating strategy within registered plans. Using the sale of naked put options to take possession of specific gold stocks at lower prices, all the while taking advantage of above average option premiums!

With that in mind, you might want to look at Franco Nevada (Listed on the TSX, symbol: $56.59). You could write, say, the April 58 calls at $2.10. The two month return if exercised is 6.015%, while the return if unchanged is 3.71%.

For the naked put strategy, consider writing the Goldcorp (symbol G, $29.77) July 28 puts at $1.60. If the stock stays the same or rises you will retain the premium from the sale of the naked put. That is your maximum potential return. If the stock declines you will purchase the shares at a net cost of $26.40, which is calculated as the strike price less the premium received. With this strategy, you should be comfortable holding the shares at that price.