March 14, 2003
Prospecting at PDAC

As the global stock markets rally back from the abyss - the major U.S. markets had their best day of the year yesterday, the Nikkei is back above 8,000, and the FTSE is up by more than 9% in the last two days – yet another awful US economic report has been released.  This time it was February retail sales, which were down 1.6% (down 1% excluding autos).   The optimistic interpretation of this report is as follows: consumers were to cold and to busy watching Iraq-TV to shop. However, the pessimistic – or more realistic – interpretation is that the US consumer, laden with a record amount of debt and losing confidence because of rising unemployment, are adjusting their spending/savings habits to more historically normal levels. 

The Iraq-Rally

No one has a clue what is going to happen in the coming days. Nevertheless, it is becoming increasingly apparent – judging from mob rules psychology – that stocks will rally following a successful Iraq war. There remains considerable doubt as to exactly when the war will begin and/or whether or not another vote will go through the UN first.

Returning To The Range

Including July 1, 2002, there has been 177 trading sessions. In 125 of these sessions (or 70% of the time) the Dow closed between 8,000 and 9,000.
  


Prospecting at PDAC

I took in two Investor Forum’s at the Annual Prospectors and Developers Association of Canada (PDAC) conference: Gold Stock Analyst’s John Doody, and Gold Mining Stock Report’s Robert Bishop. 

Gold Stock Analyst

Using current account deficit/gold bull market comparisons, Mr. Doody illustrated that gold is likely to rally to $450 an ounce during its current up-cycle.  Doody went through 9 of the top 10 companies covered by The Gold Stock Analyst. While a handful of these stocks – including Canyon Resources, Crystallex, and Arizona Star (stake in Cerro Casale) – are long shots, Doody instead elected to refer to them as potential ’10 baggers’ (or stocks that could go up 10 fold). Beyond these speculative picks, Doody’s list was rounded out by large cap producers like Newmont, Gold Fields, and Anglogold.

Gold Mining Stock Report

Mr. Bishop wouldn’t speculate an exact future gold price, but he did say that the current up ‘cycle’ will likely take gold higher than has ever been ($850+ an ounce).  He highlighted 4 companies – including Nevsun and Orezone Resources - and noted that investors should not be averse to taking profits during what he expects to be a choppy long-term rally.

No Hedging

While both Doody and Bishop illustrated why they were bullish on gold – the dollar will weaken, producer hedging previously held the POG down, etc -- what neither presenter mentioned was using covered calls to lock in profits.  This was surprising given that both individuals praised Newmont as being the best managed (Doody) and/or an obvious core holding (Bishop).  Consider the options chain on Newmont (as of Wednesday’s close)

Newmont Out of the Money Options Chain (Bids Only)

 

 

 

 

 

 

 

Current Price:

$24.8

 

 

 

 

 

 

 

 

 

 

Strike

Apr-03

Jun-03

Sep-03

Jan-04

Jan-05

25

1.30

2.20

3.00

3.90

5.70

27.5

0.55

1.25

2.05

-

-

30

0.15

0.70

1.35

2.10

3.90

 

 

 

 

 

 

Options Premium (Based as a percentage of current stock price)

25

5.24%

8.87%

12.10%

15.73%

22.98%

27.5

2.22%

5.04%

8.27%

 

 

30

0.60%

2.82%

5.44%

8.47%

15.73%

 

 

 

 

 

 

Total Percentage Invesment Gain if Options are Exersized

 

25

6.05%

9.68%

12.90%

16.53%

23.79%

27.5

13.10%

15.93%

19.15%

-

-

30

21.57%

23.79%

26.41%

29.44%

36.69%


Yes, using covered calls is not for every investor.  Nevertheless, if an investor firmly believed that Newmont was a solid long-term holding, as both Doody and Biship do, why not earn a healthy premium for simply holding your shares?  For example, Newmont closed at $24.80 on Wednesday and the bid on the $30 Jan 04 calls was $2.10. For the long-term holder writing this call contact makes sense for two reasons:

1) The ‘options premium’ is your downside protection.  Since you receive $2.10 a share for writing the calls, you are not holding a losing position until $22.70.

2) The worst that can happen if you are long-term holder of Newmont (next to the shares going below $22.70) is that the calls are exercised. Something tells me no investor would be overly upset if this happened, as they would be ‘stuck’ holding a 29% gain before commissions and taxes (not including dividend gains).

Gold Cycle Investing

At one point during his presentation Mr. Bishop asked the audience of roughly 300 how many investors were disappointed that they didn’t take some profits a week earlier (or before most gold stocks began to drop).  Much to his dismay (Bishop was upset he did not take profits), only a 3 or 4 people in the crowd raised their hands. The basic observation from this was that most of the investors/analysts in the audience wanted the ‘10 baggers’; they wanted to be apart of the long-term up cycle in gold and didn’t care much about short term volatility.

The phrase ‘gold cycle’ was incessantly used by Doody and Bishop, yet neither individual mentioned the advantages of owning hard hold, or hedging long term equity positions by using covered calls. Quite frankly, investing in the ‘gold cycle’ using Doody’s or Bishop’s methods can prove hazardous to an investor’s health, unless the POG continues to rally.  Given that Iraqi developments have taken gold lower perhaps the word ‘unless’ should be replaced by the word ‘if’ (or when)?

In sum, the bulk of the exhibits at the PDAC conference were run by startups: companies holding a shovel in one hand and looking for cash with the other.  The case can be made that investors that chase gold stocks because they believe gold is in a long-term up cycle are essentially holding their hands open and waiting for cash. This is not say that gold cycle investors will not be rewarded, only that while waiting for the ‘long-term’ to arrive they may wish they had taken profits and/or hedged their position from time to time.

BWillett@fallstreet.com

All data and information within these pages is thought to be taken from reliable sources but there is no guarantee as such. All opinions expressed on this site are opinions and should not be regarded as investment advice.
Copyright © 2000-2003. FallStreet.com