The Golden Mean

Gold stocks are strange hybrids. On the one hand, they are influenced by the price of gold. On the other, they are operating companies whose share price is governed by the usual: revenue, earnings, and debt. That Jekyll-and-Hyde personality can spell opportunity for nimble options traders looking to gain from short-term trends.

Even though gold has risen on the year, mostly a result of “flight-to-safety” buying, shares of gold mining companies have languished, along with most other materials issues on the TSX. But then gold mining companies tend to trade in rather large ranges driven by the perception of gold as a raw material or as crisis insurance. Certainty the S&P/TSX Composite Index is now down 10% from its recent high, putting it squarely into correction territory.

Corrections at this stage of a market cycle tend not to last for very long. Much will depend on the US market and whether it can gain some footing. If the US market is able to stabilize, we could see a rally from these lows sometime over the next few weeks. Technically, stocks that have been oversold are likely to get the biggest pop when things start moving again. And gold stocks fit into that category.

There are a couple of fundamental issues to consider. Fed Governor Ben Bernake will be making another impromptu television appearance near the end of June. To coincide with the ending of QE II!
For traders the issue comes down to whether Mr. Bernanke is likely to engage in QE III?

Here’s where it gets interesting. Should gentle Ben state definitively that there will not be a QE III, the US dollar will rally. That would be bad for gold, but not necessarily for gold stocks. It would signal that the US economy is on a solid footing, and that should be good for materials. Stocks in general may weaken initially, but once the market reflects on his inference, it may well rally.

If there is ambiguity in his comments, there is a higher likelihood that the market slips. Which in and of itself, could cause the Fed to rethink QE III. In any event, that would be bad for the USD dollar and good for gold and gold stocks.

If you are an aggressive trader and want to bet on an upside surprise in gold mining stocks, you might want to look at buying calls. Particularly on some of the larger miners whose shares have been beaten down in the market slump.

These include Goldcorp (TSX: G, Friday’s close $45.40), Barrick Gold (TSX: ABX, $42.23) and Kinross Gold Corp. (TSX: K, $14.73). Alternatively, take a position on iShares S&P / TSX Global Gold Fund (TSX: XGD, $22.11) to get exposure to the entire sector.

With G, look at the July 46 calls at $1.25. For ABX, the July 44 calls at 65 cents look interesting and with K, consider the July 15 calls at 45 cents. Finally, with XGD, you need to be mindful of the limited liquidity. There is very little open interest and the options trade by appointment. However, if you want the sector exposure, the June 22 calls at 65 cents are a possibility.