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Gold Vehicles (Not the Chariot Type)

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Gold Vehicles (Not the Chariot Type)

As promised last week, if enough faithful readers sent in e-mails requesting such, we'd do an article on the different vehicles available for precious metals trading and investing. Enough readers responded - more than I'd imagined, actually - so we're going to spend some time today on gold vehicles, none of which are available at any of the Big 3 automakers' showrooms!

Before we get started, I encourage those just joining us for the first time on the subject to go back to last week's article on the case for gold.

http://www.optioninvestor.com/page/oin/education/opt101/2003/02-06.html

I'd also encourage everyone, even the trading pros, to read Jonathan Levinson's excellent article from last night.

http://www.optioninvestor.com/page/oin/education/traders/2003/02-12.html

It dovetails very nicely with what we'll jump into right now. Where Jonathan Levinson does a great job with the principles for choosing certain vehicles, we'll focus on the vehicles, themselves.

For starters, HUI.X, commonly known as the un-hedged gold index, is not tradable to the best of my knowledge. No options are available, nor is there any volume of shares to indicate an exchange traded fund (EFT). However, we can use HUI as a barometer or marker with some correlation to the price of gold. The following companies in the index are considered un-hedged, though "un-hedged" is a bit of a misnomer given that up to one and a half years of forward sales (hedging or shorting) is still permissible under the definition:

CDE - Coeur D'Alene Mines
FCX - Freeport McMoran Copper Gold
GLG - Glamis Gold
GG - Goldcorp
HGMCY - Harmony Gold
HL - Hecla Mining
MDG - Meridian Gold
NEM - Newmont Mining

The next index is probably the most commonly known - XAU.X, referred to as the Gold and Silver Index, and is also not tradable. However, options are tradable on this index on the Philadelphia exchange. Just because HUI is referred to as the "un-hedged" index does not necessarily mean that XAU represents only "hedged" companies. In fact there are a bunch that overlap. The following are the stocks that make up the XAU:

AEM - Agnico Eagle Mines
AU - Anglogold
SIL - Apex Silver Mines
ABX - Barrick Gold
FCX - Freeport McMoran Copper Gold
GG - Goldcorp
HGMCY - Harmony Gold
MDG - Meridian Gold
NEM - Newmont Mining
PDG - Placer Dome

If our plan is to trade options in the gold market, XAU is pretty much the only vehicle providing any connection with the price of gold.

If that's too lightweight, we can always play with the big boys in the futures market. The contracts expire in different months of the year and in future years too. The current month contract is GC03g (GC for Gold Contract; 03 for 2003; g for February). However, volume has dropped to a trickle on these in favor of most front month trades done under the symbol GC03j (again, GC for Gold Contract; 03 for 2003; j for April). GC03m is the June contract.

Each contract controls 100 troy ounces of gold. Thus at current levels, one contract will set us back roughly $35,750 at today's closing price of $357.50 per ounce. The good news is that futures provide us tremendous leverage. As Jonathan correctly pointed out yesterday, although the initial margin requirement was just increased to $2025 per contract from the previous $1500 per contract, it's still a bargain. Of course, that works in reverse too in that a move to $337.25 per ounce of the metal wipes out the $2025 we plunked down and begins costing us dearly if the price declines further.

In the realm of trading, only the latter two are suitable trading vehicles. These are not the instruments of those who want protection from either financial meltdown, or merely financial erosion. They are strictly trading vehicles in my opinion, and not designed for a long-term investor. Whether we use them or not depends on our time horizon and our reasons for involving ourselves in gold plays. Trader's horizon, good. Investor's horizon, bad.

Traders can also avail themselves of gold and/or silver stocks, most of which are optionable. However, we're beginning to cross over into investor territory here too. As investors, we'll be interested in instruments that never expire (though they can go bankrupt or otherwise be wiped out), and that includes stocks of individual mining companies, some of which even pay dividends(!), meager as they are.

I don't have a favorite mining or exploration stock, except maybe Newmont (NEM), which I'll get to in a minute. I'm not really fond of them for a number of reasons, the biggest of which is that they are still stocks!

So what's the problem with that? Keep in mind the reason that I am personally invested in gold - an insurance policy that never expires against financial catastrophe. Now if there is a financial catastrophe, metal stocks are going to suffer too for the same primary reason as any other stock. While metal stocks may be slightly insulated by virtue of their inventory or reserves of metal, as a reader astutely commented, their profits are still derived in fiat currency. For that reason, I'm on the fence about purchasing individual mining companies. If things ever get that tough internationally, I'm not going to be able to spend a stock certificate as a last resort, even if it is a mining company. Maybe there won't even be a liquid exchange in which to sell it.

The secondary reasons are that shares are overpriced as a multiple of earnings. Or worse, they have no earnings even after the sharp rise in the price of gold. Criminy, what's it take to make a profit if it can't be done at $350 per ounce?

Another piece of treachery in the individual companies is that they can't just start producing at the tip of a hat. There is some ramp-up time. For you real estate developers, if you thought building a shopping center, warehouse, or office building was a tough sell to the local zoning board, try developing a gold mine! It's no surprise that 10 years is a reasonable development time, at least in the U.S., and that foreign countries might be a bit more lenient in the development process.

Therein lies another risk in mining in foreign countries. What is it? In a word, nationalization - confiscation, re-possession, co- opting, pilfering - call it what you want, but it's stealing. So you have event risk in any given mine.

Those are all reason why I tend to shy away from the shares under my "ark-building" program. None of this matters to the trader though. As traders, we only care about action. Investments are the furthest thing from our minds. For that reason, I keep my eyes on a bunch of individual mining stock symbols. By no means am I recommending any of them. You've already observed some of them above, but I've listed them here in alphabetical order:

ABX, AEM, ASA, ASL, AU, BGO, CBJ, CDE, DROOY, ECO, GFI, GG, GLG,
GSS, HL, HMY, KGC, MDG, NEM, PDG, RGLD, SIL, and SSRI.

Some of these are priced under $5 and have the possibility of running up 10-fold or more. I just don't know which ones, and I'm not gambler enough to buy 10 at random with a throwing of the proverbial dart, and hope I've nailed a home run. I'm just not well-versed enough in the industry to know the winners from the losers. Yes, there will definitely be both!

I mentioned NEM a minute ago for good reason. It is, I believe the closest thing to investment grade in terms of safety for a couple of reasons.

First, it's the biggest capitalized mining stock out there, and it pays a dividend. To boot, it has operations in more countries than any other mining company I can think of. Thus it is not as vulnerable to event risk in any one location as those with less far-flung operations.

Second, if run of the mill mutual funds are eventually to gain some exposure to gold, and they can pick only one stock, I think they are going to first buy NEM for the reasons I noted above. That doesn't make it a buy, but it's the highest on my radar screen. So I keep an eye on it.

Now if none of this sounds like fun investigating 20+/- individual stocks, most not based here in the U.S., we are birds of a feather. For that reason, I'm inclined to give my money to a metals mutual fund manager and let him/her do the picking for me. There are many funds out there to pick, as well. By no means is this a complete list; there are many more. But here are a few I swerved into over the last year.

GOLDX - Gabelli Gold
MNTGX - Monterrey Gold
RYPMX - Rydex Precious Metals
SGGDX - First Eagle Gold
TGLDX - Tocqueville Gold Fund
USAGX - USAA Precious Metals
EKWAX - Evergreen Precious Metals
INIVX - Van Eck Intl.
SCGDX - Scudder Gold

Disclosure: I own some Tocqueville shares.

Dang! Just when I was getting to the good stuff, I hit the wall of time and space - not quite the Twilight Zone, but deadline and allotted space dictate here.

Next time, we'll tackle the purchase of coins, bullion, and the closest thing to gold certificates we'll ever see, CEF shares, which can be owned in your IRA!

Until next time, make a great weekend for yourselves!

Buzz



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