Gold Miner’s Turnaround Can Earn You Income Even if Shares Go Nowhere

Turns in investor sentiment can make you double- and even triple-digit gains if you are early enough. The risk is being too early. The wait can be excruciating — and costly. 

Just ask gold bugs. 

Historic money printing by the largest central banks should have stoked inflation, deflating currencies and sending gold prices higher. And the 30% plunge in gold prices in 2013 should have led to production cuts and greater demand. Yet, gold prices have gone nowhere since the beginning of 2014.

Gold Chart

The wait for gold to rebound has led to big losses for many. SPDR Gold Shares (NYSE: GLD) is nearly 11% off its 52-week highs, and the Market Vectors Gold Miners ETF (NYSE: GDX) is down 29% from its highs of the past year.

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But for the leader in the space, this year may be a turning point. Better still, we can make double-digit returns even if the stock goes nowhere.

Where are the Gold Bugs Now?

Relative to the fervor for gold over the past several years, it seems you hardly hear pundits talk of the yellow metal anymore. 

The price of gold has traded in a narrow band between $1,350 and $1,150 since the beginning of 2014, and has spent much of the time around $1,200 per ounce. 

The average all-in sustaining costs (AISC) of the largest 10 gold miners averaged $956 in 2014. This left a thin margin for returns. AISC is a measure of direct operating and corporate costs, plus the necessary exploration and capital investment to sustain current production levels, but it does not include other charges like taxes and interest. 

The steep drop in gold prices since 2011 should have led to lower production, especially among the smaller miners where AISCs are higher. Gold bugs have been waiting on lower production, and presumably higher demand from lower prices, to send gold prices higher, but it has not played out.

But one company may be able to manage a turnaround even with the current price of gold.

Best-of-Breed Miner Ready for a Turnaround

Barrick Gold (NYSE: ABX) is the world’s largest gold producer with 6.2 million ounces of gold and 436 pounds of copper mined in 2014. At the end of last year, the company booked 934 million ounces in proven and probable gold reserves and 9.6 billion pounds in copper reserves.

Shares of Barrick have been hit along with other miners and lost 75% of their value since their 2011 peak. The company has booked negative free cash flow (FCF) for three consecutive years but is adjusting to the new reality in prices. Aggressive cuts in expenses and a focus on core mines with lower cash costs could mean a return to positive FCF this year.

The company’s five core mines in the Americas account for 60% of production and have an AISC of approximately $750 per ounce. Total gold production, which accounted for 85% of revenue in 2014, came in at an AISC of $864 per ounce last year and is expected to be between $860 and $895 per ounce in 2015. 

Management guided 2015 cuts to expenses of $30 million, followed by another $70 million in cuts next year. Capital spending is expected to be 11% lower at approximately $1.9 billion this year, and management expects to book positive free cash flow. A return to positive FCF could support investor sentiment and send shares higher.

Management’s 2015 guidance is based on gold prices of $1,200 per ounce and copper prices of $2.60 per pound. Both of these estimates are below the current market prices for the metals, and further price increases over the rest of the year could add to cash flows.

Earn Income Before Gold’s Momentum Returns

While the potential for a return to positive FCF could send ABX sharply higher, I want to protect myself. Global economic growth is still fairly weak and keeping inflationary pressure tame. The rise in the U.S. dollar may further dampen gold prices until the economies in Europe and China strengthen. 

Fortunately, using a put selling strategy means I don’t necessarily need the shares to jump higher to book strong cash returns. Many people think options are too risky, but when done properly, put selling is a conservative, high-income strategy.

By selling put options, I agree to buy the shares if they are below a certain price (the option’s strike price) at a certain date in the future. For taking on this risk, the option buyer pays me a premium and I have a net credit on the trade. If the shares close above the strike price when the option expires, I do nothing and keep the premium. 

The premium also lowers my cost basis in the shares, so even if I have to buy them, it will be at a price that is below the point where I was contemplating a position anyway. 

Each option contract represents 100 shares of the underlying stock or ETF. In addition to only selling put options on stocks I want to own, I also only sell as many contracts as I can cover. This is called a cash-secured put, and it means I have enough in my account to cover the strike price minus the premium, multiplied by the number of shares I’m obligated to buy.

Basically, selling puts gives me immediate income, which offers downside protection, and I may book a return without ever having to buy the shares. 

If you’re still not keen on the strategy, before you continue, I urge you to check out this short tutorial. In it, an options expert reveals how she’s used a put selling strategy to close 85 straight winning trades with an average 53% annualized gain per closed trade — and how you could collect hundreds of dollars starting this week. Click here to watch.

With shares of ABX trading at $12.29 at the time of this writing, we can sell the ABX Jul 12 Puts for about $0.48 per share ($48 per contract). If ABX closes below the $12 strike price at expiration on July 17, we will be assigned shares at that price. Since we received $0.48 in options premium, our actual cost basis is $11.52 per share, a 6.3% discount to the current price. 

As I said, we want to make sure we have enough money in our account to cover the purchase. This means setting aside $1,152 for every put contract we sell, plus the $48 we collected from selling the puts. 

If ABX closes above $12 on expiration, we keep the premium for a gain of 4.2% in just 53 days. That works out to an annualized return of 29% — and the shares do not have to go anywhere.

If you’d like to learn more about putting this strategy to use in your portfolio, we’ve been lucky enough to get an expert with a 100% success rate over the past two years to sit down and share her technique with us. You can access it here.