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How to Earn Income From a Stale Gold Share

Commodities / Gold & Silver 2009 Aug 19, 2009 - 06:32 PM GMT

By: Oakshire_Financial

Commodities

Best Financial Markets Analysis ArticleIn keeping with the theme we promised in the last issue of the Residual Income Report, we hereby present the second instalment in our series, Get Smart; Get Gold Income.


If you recall, last week we suggested the ‘Silver Switch’ strategy, which involved taking non-performing silver bullion or non-dividend-paying silver shares and switching them into convertible bonds or convertible preferreds from silver miners.  (The trade, by the way, works equally well with non-producing gold assets, too.)  In this way, you’ll attain all the benefits of exposure to the precious metals sector and regular income while you wait for the metal to rise.

This week we take a slightly different approach.

Regular Income is the RIRs Raison D’Etre (That’s French, Igor)

There are a number of ways to earn a healthy monthly or bimonthly paycheck from the precious metal or precious metals stock you already own and are loathe to part with.  Simply sell options against them.

Selling calls against a position you plan to keep is a tried and true method of reducing your original purchase cost and generating a regular income.

Here are two specific trades it will pay you (literally) to consider.

  • Newmont Mining (NEM:NYSE) is one of the world’s largest gold producers by market cap.  Worth more than $20 billion, the company is also one of the few gold producers that pays a dividend – nominal, to be sure, but a dividend, nonetheless.  And that only adds to the attractiveness of the trade.  Here’s the way Newmont has performed over the last two years:

Like most of the large gold producers, there’s been plenty of action on Newmont shares over the last couple of years.  But unless you bought at the bottom in the fall of 2008, there’s been very little profit to be had from the stock.  Here’s a way to remedy that.

For every 100 shares of Newmont you own, sell one September, 2009 call option with a strike price of 45.  If you don’t already own the stock but like the precious metals and gold in general, consider a simultaneous purchase of the common stock and sale of the calls.

Here’s the math:

  • Your purchase of 100 NEM shares (currently trading at $41.14) will cost you – $4114.
  • Your sale of one NEM 45 Call option will net you – $130.
  • Your quarterly dividend on 100 shares of Newmont will net you – $10.

Your total cost, therefore, to set the trade is – $3974.

Writing Calls on Stock You Own Makes Your Assets Productive

If Newmont stock rises to 45 before the September options expiration, and your shares are called away, you will receive – $4500.  Your net gain for the trade is:

$4500 - $3974 = $526

Your profit divided by your initial investment equals your rate of return:

$526 / $3974 = 13.24%

Not a bad take for two months.

And what if Newmont shares do not rise above the $45 level before the September options expiration?  What if they continue to move sideways or drift lower with the rest of the precious metals complex over that time span?  Simply initiate a new sale of call options and take in more income.  And, if necessary, continue to do so until your adjusted cost base for the shares is next to nothing.

The key here is to be committed to the precious metals for the long term.  There’s no question that the prospects for gold and silver are promising.  The question is whether you can afford to tie up great sums in these assets while you’re waiting for the next big move in the metals.  Remember: non-producing assets (dead money) are anathema to a healthy investment portfolio.  Writing covered calls on gold stocks and bullion is one sound method of taking in cash while you wait it out.

Just another brief word on Newmont before we continue.  The company is sound, with probable and proven reserves of some 85 million ounces and operations in a diverse but politically safe geographic base.  Consider also: Newmont, like many other large producers, will make the greatest gains when the gold shares next move higher.  Institutions seeking to participate in the rise in precious metals shares will turn first to the senior producers, and only afterwards to the juniors.  On the downside this holds true as well.  If gold should take a tumble from current levels around $940, the senior producers will hold their value far better than the juniors.  A word to the wise should suffice.

A Second Major Gold Producer

Compania de Minas Buenaventura SA (BVN:NYSE) is another of the world’s majors, with a market cap of $6 billion and operations centered in Peru.  Here is a chart of the last two years’ trade on BVN stock:

If you bought the company’s shares at any time during this period you would have a 50-50 chance of being in the black.  And for those who prefer to adopt a ‘wait it out attitude’, we suggest there’s a better alternative.

The trade on BVN is very similar to that of Newmont and breaks down mathematically as follows:

  • Buy 100 shares of BVN at $23.41 for – $2341
  • Sell one September 25 Call contract (for every 100 shares of BVN purchased) for a net gain of – $120

Your total adjusted cost base for the trade is:

 $2341 – $120 = $2221

If Minas Buenaventuras rises to $25 before the September options expiry, and your shares are called away, you will receive $2500.  Your net gain for the trade is:

$2500 - $2221 = $279

Your profit divided by your initial investment equals your rate of return:

$279 / $2221 = 12.56%

Again, a return of this magnitude in just two months is something to be pleased with.

The Residual Income Report recommends initiating covered call trades on Newmont Mining (buy the common and sell the September 45 Call) and Minas Buenaventura (buy the common and sell the September 25 Call).

And don’t be a ‘gold hoper’.

Make money!

Matt McAbby
Analyst, Oxbury Research

After graduating from Harvard University in 1989, Matt worked as a Financial Advisor at Wood Gundy Private Client Investments (now CIBC World Markets).  After several successful years, he moved over to the analysis side of the business and has written extensively for some of corporate Canada's largest financial institutions.

Oxbury Research originally formed as an underground investment club, Oxbury Publishing is comprised of a wide variety of Wall Street professionals - from equity analysts to futures floor traders – all independent thinkers and all capital market veterans.

Copyright © 2009 Oxbury Research - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Oxbury Research Archive

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