Oppenheimer: Gold Miners Have 40% Upside

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 |  Includes: ABX, GDX, GDXJ, NEM
by: Bret Jensen

Summary

Oppenheimer came out today with a call that gold mining stocks could see a breakout of up to 40% to the upside.

After underperforming for years, gold miners are starting to outperform the underlying price of gold.

There are a variety of ways to play this call including my favorite possible acquisition in the space.

Oppenheimer made an interesting call today on gold mining stocks. Oppenheimer's technical analyst believes the Market Vectors Gold Miners (NYSEARCA:GDX) can soar more than 40% from current levels to his price objective of $38, levels not seen since March 2013. Miners have vastly underperformed the price of gold since 2006. However, Oppenheimer's technical analyst pointed out that on a relative-strength chart, plotting the GDX against the SPDR Gold Shares (NYSEARCA:GLD), shows that the GDX has finally broken out from a long-term downtrend, suggesting a new trend of outperformance is underway. Gold miners' horrid performance against gold and the overall market over the past five years can be seen below.

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My regular readers know that I would never purport to be a technician. My reasons for holding a higher allocation in gold miners than usual right now are more contrarian in nature. The sector has been one of the leading laggards of the last three years even as the overall market has soared.

More importantly the miners have finally got religion over the last six to 12 months. They have sold non-core assets, cut capital budgets, postponed or canceled new mines and are taking an ax to operating costs. I would also expect mergers and acquisitions to pick up as miners increasingly focus on economies of scales and not organic production growth.

My favorite merger play right now is Barrick Gold (NYSE:ABX). The company has engaged in on again/off again merger talks with Newmont Mining (NYSE:NEM) over the years. Barrick's CEO recently left and Newmont's leader said he was "open" to renewing talks. This merger almost makes too much sense not to eventually get done. Both companies get approximately 40% of their gold production from Nevada and there would be significant cost savings by combining.

Barrick looks expensive based on the paltry 70 to 80 cents a share in profit it is likely to deliver in 2014. However, the stock goes for less than eight times trailing earnings and under five times the earnings this miner delivered in 2010 and 2011. Finally, after trading in a relatively tight trading range for a year, the stock just crossed over its 200 day moving average and could be breaking out (See Chart).

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For investors that want diversification, the GDX gold miner index offers this benefit. For those willing to go out on the risk scale, the Market Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ) could make sense as it sells for a lower price to earnings ratio and lower price to book value than its larger brethren. However, the index is also more volatile and the bigger miners should get the lion's shares of the current focus on lowering operating costs. Given that this sector is highly volatile and so dependent to the price of the underlying yellow metal, those comfortable with options might want to consider long term call options or bull call spreads.

Disclosure: The author is long ABX. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.