The One Stock I'd Pick to Play the Precious Metals Rebound

Ford Motor Co. (NYSE: F) recently announced that May was the best month for its truck sales in six years. Truck sales offer some insight into the state of the economy. Increased truck sales confirm higher consumer confidence. Trucks are gas guzzlers, and many consumers will only buy them and other large vehicles if they are confident they can afford the gasoline.

Auto sales are also growing with manufacturers reporting that new-vehicle sales are up 8.2% compared to a year ago. Analysts expect sales to reach 15.3 million this year, up from less than 14 million in 2012, and up over 50% since the recession lowered annual sales to about 10 million.

Auto stocks are one way to trade this news, but I think their suppliers can be better trades. Platinum and palladium are used in catalytic convertors and could increase in value along with the demand for cars and trucks.

These two metals are also the leaders within the precious metals sector and show more promise than gold or silver. ETF demand for all metals is rising. Over the past six years, ETFs increased their holdings of gold by 24% a year. Silver ETFs saw similar gains. Demand for platinum increased 169% a year, while palladium funds increased their holdings by 132% a year.

Stillwater Mining (NYSE: SWC) is the only U.S. producer of palladium and platinum.

SWC expects to mine 500,000 ounces of palladium and platinum this year. In the first quarter, palladium accounted for about 78% of its production. The company also generates significant amounts of metals for sale through a recycling division and reaps large amounts of nickel and copper as byproducts from its mining operations.

A large portion of its production, about 86% of the mined palladium production and 74% of its platinum production, is already sold under delivery agreements with General Motors (NYSE: GM), Ford, Tiffany & Co (NYSE: TIF) and other customers. These sales are priced at a small discount to the market price. The rest of SWC's production is sold on the spot market at the current price.

Price increases in the metals market translate to higher revenue for SWC. The company expects its cash costs of production to be about $560 per ounce, an amount that should be relatively insensitive to market prices. This means that higher metals prices should also translate to higher earnings for SWC.

If the price of the metals goes up by 10%, from an average of $939 last quarter to $1,032, for example, the company's operating profits should increase by 25% (from $379 per ounce to $472). That leverage in earnings is what makes mining stocks attractive.

If metal prices increase an average of 10%, SWC could gain more than 20%. The stock is currently priced near $12.40 and could be worth as much as $14.50.

Call options on SWC allow for an even greater potential return if metals rise. A call option gives the buyer the right to buy 100 shares of stock at a predetermined price until a predetermined date. In the worst case, your loss is restricted to what you paid for the call.

Options expiring in October with an exercise price of $12 are trading for about $1.60. If SWC reaches $14.50, the call would be worth at least $2.50. This would be a gain of 56% on the option.

Risk can be limited with a stop-loss order. If the call falls below $1.05, the trade should be closed. This should happen only if SWC falls about 10% in price. A decline like that in the stock would mean the call is unlikely to be profitable at expiration.

If platinum or palladium move significantly higher, the gains in SWC should be even greater. With a call option to limit the risk, SWC could be the best way to profit from a recovery in automobile manufacturing and a rebound in metals prices.

Recommended Trade Setup:

-- Buy SWC Oct 12 Calls at $2 or less
-- Set stop-loss at $1.05
-- Set initial price target at $2.50 for a potential 25% gain in four months

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