Hedging The 10 Highest-Rated Gold And Silver Stocks

by: David Pinsen

Richmont Mines Ranks Highest

Richmond Mines, Inc. (NYSEMKT:RIC) posted third quarter earnings on Monday of $0.19 per share, more than double the $0.08 per share it earned in Q3 of last year. As of Thursday's close, Richmond Mines was also the highest-rated gold or silver mining company in VectorVest's universe (VectorVest combines gold and silver mining companies into one industry group), with a VST ranking of 1.29 (on a scale from 0 to 2). Recall that VST (Value, Safety, Timing), VectorVest's master ranking, is comprised of a weighted average of its Relative Value, Relative Safety and Relative Timing indicators, with Relative Value underweighted and Relative Timing overweighted.

Hedging The 10 Highest Rated Gold And Silver Stocks

The table below shows the VST rankings for RIC and the next nine highest-rated gold and silver mining companies. It also shows the costs, as of Friday's close, of hedging seven of these stocks against greater-than-20% declines over the next several months (three were too expensive to hedge using a 20% decline threshold). For comparison purposes, there are the gold-tracking ETFs SPDR Gold Trust (NYSEARCA:GLD), iShares Gold Trust (NYSEARCA:IAU), and iShares Silver Trust (NYSEARCA:SLV). First, a reminder about what optimal puts are, and why I've used 20% as a decline threshold; then, a screen capture showing the current optimal puts to hedge one of the comparison ETFs, GLD.

About Optimal Puts

Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. Portfolio Armor uses an algorithm developed by a finance Ph.D. to sort through and analyze all of the available puts for your position, scanning for the optimal ones.

Decline Thresholds

In this context, "threshold" refers to the maximum decline you are willing to risk in the value of your position in a security. You can enter any percentage you like for a decline threshold when scanning for optimal puts (the higher the percentage though, the greater the chance you will find optimal puts for your position). I have used 20% thresholds for each of the securities below. Essentially, 20% is a large enough threshold that it reduces the cost of hedging, but not so large that it precludes a recovery.

The Optimal Puts For GLD

Below is a screen capture showing the optimal put option contract to buy to hedge 100 shares of GLD against a greater-than-20% drop between now and June 15th, 2012. Two notes about these optimal put options and their cost:

  • To be conservative, Portfolio Armor calculated the cost based on the ask price of the optimal puts. In practice, an investor can often purchase puts for a lower price, i.e., some price between the bid and the ask.
  • Hedging costs for GLD have risen considerably over the last few months. On August 3rd, the cost of hedging an odd lot (612 shares) of GLD was only 0.95% of position value, as we noted in an article published the following day ("Why You Should Consider Hedging Gold"). Bear in mind, too, that the optimal hedging costs of an odd lot are higher than they are for a round lot, for reasons we explained in that article published on August 4th.

Why There Were no Optimal Contracts for RIC, EXK, GORO

In some cases, the cost of protection may be greater than the loss you are looking to hedge against. That was the case with three of these stocks. On Thursday, the cost of protecting them against a greater-than-20% declines over the next several months was itself greater than 20%. Because of that, Portfolio Armor indicated that no optimal contracts were found for them.

VST Rankings And Hedging Costs As Of Thursday's Close

The gold and silver mining companies below are listed in descending order of their VST (Value, Safety, Timing) rankings as of Thursday's close. The hedging data is as of Thursday's close as well.



VST Ranking

Hedging Cost

(RIC) Richmont Mines, Inc. 1.29 No Optimal Contracts
(NASDAQ:GOLD) Randgold Resources 1.28 8.69%***
(NASDAQ:RGLD) Royal Gold, Inc. 1.27 4.98%*
(NYSE:AUY) Yamana Gold, Inc. 1.26 7.17%*
(NYSE:BVN) Compania de Minas Buenaventura, SA 1.24 11.0%***
(NYSE:GG) Goldcorp Inc. 1.24 5.04%*
(NYSE:EXK) Endeavour Silver Corp. 1.22 No Optimal Contracts
(NYSE:CDE) Coeur d'Alene Mines 1.17 18.2%***
(NYSEMKT:GORO) Gold Resource Corp 1.17 No Optimal Contracts
(NYSE:ABX) Barrick Gold Corp. 1.16 4.85%*
(GLD) SPDR Gold Trust 1.00 2.63%***
(IAU) iShares Gold Trust 1.00 3.20%*
(SLV) iShares Silver Trust 0.93 7.18%*

*Based on optimal puts expiring in April 2012.

**Based on optimal puts expiring in May 2012.

***Based on optimal puts expiring in June 2012.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.