UXG: Can We Buy It At A Better Price Than Rob McEwen?
Looking for a potential long term investment in a junior gold miner at this stage of the game carries significant market risk with gold trading near all-time highs, and the stock market perched precariously near highs not visited in nearly three years. Managing risk is the key to successful investing; and there is not much better endorsement for the future success of a company than a CEO who has a proven track record, reportedly takes no salary from the company, and owns a full one fifth of its equity.
US Gold (NYSE:UXG) is engaged in the exploration of gold and silver in Nevada and Mexico. The project in Mexico now has a resource of over 60 million ounces of silver; and the company recently released a preliminary economic assessment targeting production of 5 million ounces silver and 50,000 ounces gold per year by 2014.
We consider insider buying as one of the best leading indicators for the future performance of any company. Impressively, the Chairman and CEO, Robert McEwen now owns more than 20% of the company after he acquired almost $20 million of its stock at $6.50 a share pursuant to a public offering that closed last week. The company obtained net proceeds of more than $105 million pursuant to the public offering. The company intends to use the proceeds from the offering to bring the project in Mexico to completion. Normally, a dilution of stock is the bane of mining company shareholders; and this time may be no different. However, McEwen's substantial transparent stake taken at $6.50 a share is a signal to shareholders that the risk may be well worth taking.
McEwen has been the Chairman, CEO, and largest shareholder of US Gold since July, 2005. Previously, McEwen was the founder, former Chairman and CEO of Goldcorp Inc. U.S. Gold's website states:
“During his tenure at Goldcorp, McEwen transformed the company from a collection of small companies into a mining powerhouse, growing its market capitalization from US $50 million to approximately $8 billion. More importantly, the shares of the company produced a compounded annual growth rate of 32%.”
We think that the combination of leadership, participation in the risk by management, no debt on its balance sheet, and assets in the ground make UXG a compelling long term investment. But how can we accumulate its stock and get a better deal than Rob McEwen?
Buy UXG stock at $7.20 or better;
For every 100 shares you buy, sell 1 January 10.00 call for .75 cents;
Additionally, for every 100 shares you buy, sell 1 January 5.00 put for .55 cents.
Here's how this may work out:
UXG trades between $5.00 and $10.00 between now and mid-January 2012, the options all expire worthless and you're left holding your UXG shares at an average price of $5.90; or
UXG trades above $10.00 in mid-January 2012, the calls are exercised and your stock gets called away at a profit of $4.10, including the option premium; or
UXG trades below $5.00 in mid-January 2012 and your stake in UXG is doubled at an average price per share of $5.45.
In each scenario described above, your net entry price per share is less than that recently paid by Rob McEwen. Of course, in the first scenario above, if the stock trades between $5.00 – $5.90 at option expiration, you would be holding at a loss. However, it would be no more than .90 cents per share. Similarly, if the stock is put to you in the third scenario, you would be holding at a loss of at least .45 cents per share; and the real risk to the trade is if the stock price collapses.
Under the second scenario, your $4.10 profit on an investment of up to $12.20, assuming your put sales are fully covered by cash, is an annualized return of about 36%. Therefore, we like the risk/reward profile in the event the stock gets called away..
The implied volatility on the option premium, while not irresistibly high, is acceptable. The chart picture for UXG is mixed. On a point and figure chart, the stock is performing relatively well against its peers. On a candle chart, there is a band of Fibonacci and chart support between $6.50 – $6.00. The next area of Fibonacci and chart support is at $5.30. If we do not take a full position with the initial trade, an adjustment can be made at the $5.30 level to reduce the average entry price to below $5.45 per share. You can also make adjustments to the initial entry points to suit your risk tolerance as the market moves up and down. You just have to be nimble.
Without the recent position taken by Mr. McEwen at a share price of $6.50, the suggested trade might be considered aggressive. While there are more conservative ways to trade this, including sitting on the sidelines awaiting a retracement, it fits well within our strategy to control risk.