Bullish Outlook

Long Call Position in Barrick Gold

Patrick Ceresna
December 17, 2020
9 minutes read
Long Call Position in Barrick Gold

Back in August, the investing world was stunned when legendary investor Warren Buffett revealed that he had purchased shares in Barrick Gold (symbol ABX). 

Up until then, Warren had been considered a “gold skeptic”.  In his 2011 letter to shareholders, Buffett wrote the following:

The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer’s hope that someone else – who also knows that the assets will be forever unproductive – will pay more for them in the future. Tulips, of all things, briefly became a favorite of such buyers in the 17th century.

This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand still further. Owners are not inspired by what the asset itself can produce – it will remain lifeless forever – but rather by the belief that others will desire it even more avidly in the future.

The major asset in this category is gold, currently a huge favorite of investors who fear almost all other assets, especially paper money (of whose value, as noted, they are right to be fearful). Gold, however, has two significant shortcomings, being neither of much use nor procreative. True, gold has some industrial and decorative utility, but the demand for these purposes is both limited and incapable of soaking up new production. Meanwhile, if you own one ounce of gold for an eternity, you will still own one ounce at its end.

What motivates most gold purchasers is their belief that the ranks of the fearful will grow. During the past decade that belief has proved correct. Beyond that, the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As “bandwagon” investors join any party, they create their own truth – for a while.

Over the past 15 years, both Internet stocks and houses have demonstrated the extraordinary excesses that can be created by combining an initially sensible thesis with well-publicized rising prices. In these bubbles, an army of originally skeptical investors succumbed to the “proof” delivered by the market, and the pool of buyers – for a time – expanded sufficiently to keep the bandwagon rolling. But bubbles blown large enough inevitably pop. And then the old proverb is confirmed once again: “What the wise man does in the beginning, the fool does in the end.”

Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A.

Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400 million acres with output of about $200 billion annually), plus 16 ExxonMobil’s (the world’s most profitable company, one earning more than $40 billion annually). After these purchases, we would have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual production of gold command about $160 billion. Buyers – whether jewelry and industrial users, frightened individuals, or speculators – must continually absorb this additional supply to merely maintain an equilibrium at present prices.

A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops – and will continue to produce that valuable bounty, whatever the currency may be. ExxonMobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons). The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.

Admittedly, when people a century from now are fearful, it’s likely many will still rush to gold. I’m confident, however, that the $9.6 trillion current valuation of pile A will compound over the century at a rate far inferior to that achieved by pile B.

When the Oracle from Omaha announced that he had purchased shares in Barrick Gold, the stock price gapped from $35.79 to above $40 since investors took this news to mean that he had had a change of heart regarding gold stocks.  They figured that if Warren was buying, then the situation must have changed enough that he felt that Barrick Gold was an attractive investment opportunity.

Chart 1: Barrick Gold (symbol ABX) year-to-date

Source: Bloomberg

However, once the initial excitement wore off, the price of Barrick Gold sagged, and ABX has recently traded below $30.  That is a decline of more than 25% from the highs!

Investors are not often given a chance to purchase shares at a price lower than what Warren Buffett paid, but with Barrick Gold approaching levels not seen since the spring, this presents a unique opportunity.

Now, one way to take advantage of the attractive entry point is to simply buy the stock.  Buying $10 lower than investors who chased the greatest value investor of all time definitely seems like a much better entry point.

Yet a lot has changed since Buffett’s initial purchase.  The recent vaccine development news has diminished uncertainty and, to some extent, reduced investors’ eagerness to own gold.

Instead of purchasing the stock outright and risking the entire investment, an investor could consider purchasing a call option.

The January 15, 2021 call option with a strike price of $30 can be bought for approximately $1.75.

If an investor bought 10 of these call options, they would have the right, but not the obligation, to purchase 1,000 shares of ABX at a price of $30 until January 15, 2021. 

The profit and loss diagram for this position is as follows:

Chart 2: Portfolio P&L for 10 CALL ABX Jan 2021 with a $30 strike price

Source:  Bigpicturetrading.com

The breakeven price for the position is $31.75.  This is still more than $8 lower than the price at which investors were buying ABX in the days following Warren’s announcement.

Has a lot changed since then?  Of course.  But by purchasing call options, an investor can limit the loss to the initial amount of the outlay – in this case, $1,750. 

If Barrick Gold were to return to the price paid before Buffett’s announcement ($35.79), then the investor would make a profit of $4,040.  If ABX was able to rally back to the old highs, the investor stands to double that amount, with an $8,250 profit.

Following in the footsteps of the great Warren Buffett is always an interesting proposition.  But it is even better when you can do this at a considerably lower price, while also limiting your risk, by purchasing call options.



The strategies presented in this blog are for information and training purposes only, and should not be interpreted as recommendations to buy or sell any security. As always, you should ensure that you are comfortable with the proposed scenarios and ready to assume all the risks before implementing an option strategy.

Patrick Ceresna
Patrick Ceresna http://www.bigpicturetrading.com

Derivatives Market Specialist

Big Picture Trading Inc.

Patrick Ceresna is the founder and Chief Derivative Market Strategist at Big Picture Trading and the co-host of both the MacroVoices and the Market Huddle podcasts. Patrick is a Chartered Market Technician, Derivative Market Specialist and Canadian Investment Manager by designation. In addition to his role at Big Picture Trading, Patrick is an instructor on derivatives for the TMX Montreal Exchange, educating investors and investment professionals across Canada about the many valuable uses of options in their investment portfolios.. Patrick specializes in analyzing the global macro market conditions and translating them into actionable investment and trading opportunities. With his specialization in technical analysis, he bridges important macro themes to produce actionable trade ideas. With his expertise in options trading, he seeks to create asymmetric opportunities that leverage returns, while managing/defining risk and or generating consistent enhanced income. Patrick has designed and actively teaches Big Picture Trading's Technical, Options, Trading and Macro Masters Programs while providing the content for the members in regards to daily live market analytic webinars, alert services and model portfolios.

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