Gold miners have been weak for years, but it could be time to jump in.
Granted, they have long been a value trap. Many observers, including myself, have touted the cheapness of miners relative to the price of bullion. It's been true for a long time and lured traders into the group early, but now could be a propitious time to try again because the risk/reward profile seems particularly favorable at current levels.
The classic comparison is between the Market Vectors Gold Miners exchange-traded fund (GDX), which tracks the miners, and the SPDR Gold Shares ETF (GLD), which follows the price of the metal itself. The GDX has risen less than 3 percent in the last five years, while the GLD has more than doubled. The disparity is even greater in a 12-month period, with the GDX losing 15 percent of its value. Gold has been up slightly in that time, while the S&P 500 has rallied 16 percent.
Recently, however, we have seen a trend of stocks in the materials sector bottoming out: U.S. Steel, BHP Billiton, Vale, Rio Tinto, and Alcoa are among them. Even Freeport-McMoRan is holding its ground after last week's gut-wrenching drop. And, when the broader market tanked in mid-November, many of those stocks came back quickly and proceeded to make new highs.
Now the chart on the GDX looks to have bottomed as well. It rallied from $40 to $55 between July and September, then retraced about half that move. The fund it now sitting around the $45 level where it peaked in June, so this is a logical place to expect support. A stop could be programmed around $44.50, about $2.10 below yesterday's close, with a price target of $55--more than $7 to the upside.
Some of the big companies in the industry also look inexpensive given their growth potential. Barrick Gold, for example, is expected to earn more than $5 next year, up from $3.91 in 2012, while Newmont Mining's profit is forecast to climb to $5 from $3.69. ABX closed at $35.12 and NEM at $45.50 yesterday. Analysts have raised estimates on both in the last three months even as most forecasts for the S&P 500 were lowered.
In addition, the options have been turning bullish. Yesterday ABX saw December 36 call buying while Gold Fields had unusual activity in the April 8 in-the-money calls. Upside action in McEwen Mining , an obscure junior miner based in Canada, lit up our scanners as well.
One potential trade is a bullish combination strategy in NEM. The March 45 puts could be sold for $2.65 to earn credit. The March 42 puts could be bought for $1.47 to hedge the downside risk, and the March 50 calls could be purchased for $1.18. The net cost would be zero, with a maximum loss of $3 if the stock breaks long-term support and drops to $42, but those March 50 calls would stand to generate big profits if the shares rally.
This is just an idea, not an official recommendation of any kind, and I don't plan to provide any updates or advice on it. But the risk/reward looks positive, especially with Newmont at a long-term level near $45.
Disclosure: I own FCX shares.
(A version of this article appeared in optionMONSTER's What's the Trade? newsletter of Dec. 12.)
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