Gold stocks have dropped, while the price of gold per ounce has traded between $1700 and $1600 in recent months, well above the cash costs of gold production. As a result, many gold stocks are trading at very low price-to-book multiples. Several gold miners are attractive value plays which pay reliable dividends and can be used to construct limited-risk income positions.
Go Long These Dividend Gold Stocks
2012 Est. Cash Cost ($/oz)
KGC, AUY, and ABX provide dividend income. Moreover, since each of these stocks has an active options market, investors can sell calls on these stocks to generate more income. If you seek risk exposure to the precious metals market, you can consider your work done after creating covered calls as components of a long-only income portfolio.
The Case for Hedging
How much is gold worth? Since gold has no cash flow or income stream, it has not calculable value. What's more, claiming to forecast gold trends or the daily gold price would be preposterous. Such forecasts could never be the basis of prudent investing. Ultimately, gold buyers and gold sellers trade to determine future gold prices in ways no gold trader can systematically predict.
Dividend investors can hedge covered call positions on these three stocks by buying puts on weaker gold companies or on the SPDR Gold Shares (GLD) ETF. For example, purchasing a January 2014 125-strike put for $5.85 would offset damage to the covered call positions if gold spot prices drop more than 20% in the next 19 months.
A more aggressive hedging position can be created by buying puts on AngloGold Ashanti (AU), a gold stock with $827.5/oz estimated cash cost for 2012 and a 2.47 price-to-book ratio. Investors can buy AU puts to hedge their exposure to gold, essentially insuring their investments in other firms with lower cash costs which are trading at lower valuations.
Hedging is often achievable by buying puts on an exchange-traded fund. Unfortunately, the January 2014 puts of the Market Vectors Gold Miners ETF (GDX) and its little brother Market Vectors Junior Gold Miners ETF (GDXJ) were prohibitively expensive, though well matched to these covered call positions.
A resulting hedged position would have a floor established by puts and income from the sale of calls and dividends. The value of the position at risk between the put-based minimum and the ceiling set by the call would be backed by the value of each stock's gold production. The hedged income portfolio is designed to generate alpha by taking short position while going long on cheap stocks with operations that are more robust to gold price declines.
Disclaimer: This article was written to provide investor information and education, and should not be construed as investment advice. I have no idea what your individual risk, time-horizon, and tax circumstances are: please seek the personal advice of a financial planner. This article uses third-party data and may contain approximations and errors. Please check estimates and data for yourself before investing.