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Option Tip – Wednesday, October 26, 2011
ABX Calls



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The Option Tip is “GO FOR GOLD” - ABX Calls



ABX logo

A rally is expected for gold shares and ABX is well-positioned for this run-up!

With rumors of QE3 (or at least QE2.5) swirling, commodities have found some footing lately. Gold has rallied off of strong technical support at the 1600 level and looks poised to make a run at the 50-day moving average around the 1740 level.

While physical gold has shown some life, gold stocks have languished, especially the major names. Barrick Gold Corporation (NYSE: ABX), which is one of the biggest names, is now trading at nearly the cheapest level compared to physical gold over the past two years. By looking for the relative valuation discrepancy to converge, and for ABX to be a relative out-performer to gold over the coming months, helps provide this option tip.

Supply and Demand of Gold

According to the World Gold Council, gold demand of 919.8 tons in the second quarter of 2011 showed a staggering 17% drop from the same period last year when it was 1107 tons. This was led by an astounding 82% decrease in exchange-traded fund (ETF) demand, which was offset slightly by a 6% increase in jewelry demand and a 2% increase in technology demand. To be fair, the second quarter of 2010 saw the highest demand for gold ETF's on record and it would be hard to top that.

ABX gold

However, it is important to note that although the demand in tonnage has been in decline, the value of gold demand overall has still increased due to the recent spike in gold prices. Overall gold demand value has increased from $42.6 billion in Q2 of 2010 to $44.5 billion in Q2 of 2011, a 4.5% gain. China and India continue to account for over half of investment and consumption demand for gold.

Another important thing to note, the previous three quarters before hand have seen increases in the value of gold, as well as the value of the demand. It is hard to assume that gold demand will continue to drop on one weak quarter especially with the ongoing fear in the marketplace.

Geopolitical issues and sovereign debt concerns are also expected to continue for the foreseeable future. With central banks adding to their reserves, and with no major seller of gold, the lack of supply is forecasted to prolong into the future with the lack of production growth.

ABX mine

Description of Barrick Gold Corporation

Barrick Gold Corporation is engaged in the production and sale of gold, as well as related activities, such as exploration and mine development. It also produces copper, and hold interests in oil and gas properties located in Canada through its oil and gas subsidiary, Barrick Energy.

Its producing mines are concentrated in three regional business units: North America, South America and Australia Pacific. In addition, it has a Capital Projects segment, distinct from its regional business units, to focus on managing projects. As of December 31, 2010, it held a 73.9% interest in African Barrick Gold plc, which included its previously held African gold mines and exploration properties.

Its main properties include Goldstrike, Cortez, Lagunas Norte, Veladero, Zaldivar and Porgera mines and its Pueblo Viejo and Pascua-Lama projects. On September 17, 2010, it acquired the assets of Dolomite Resources. On June 25, 2010, it also acquired the Puskwa property from Galleon Energy Inc.

The Reasoning for the Option Tip

Technically, ABX shows strong support at the 43 level and just generated a MACD buy signal, after bouncing off an over-sold condition. It is possible that ABX will make a push toward the 50- and 200-day moving average area of 49 by next January.

Barrick Gold Corporation (ABX – 47.20) had muscled higher in parity with gold futures yesterday, attracting the attention of call players in the process. At last check -- and ahead of the firm's turn on the earnings stage early Thursday -- the stock has seen roughly 18,000 calls cross the tape -- nearly twice the number of ABX calls traded, and significantly more than the security's average intraday volume of about 13,000 calls. This certainly provides some food for thought in regard to this option tip.

ABX-options-102611



The stock's 10-day put/call volume ratio on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) sits at 1.02 -- just five percentage points from a 52-week peak. In other words, options speculators have bought to open ABX puts over calls at a near annual-high clip during the past two weeks.

Historically speaking, ABX has surpassed the Street's bottom-line earnings estimates in three of the past four quarters, Thomson Reuters reports.

Competitors Comparison to Support the Option Tip

By checking how well Barrick Gold stacks up against some of its competition using a few common multiples, certainly provides some insight for the option tip.

ABX comparison-102611



As you can see Barrick has the lowest price/earnings ratio, one of the lowest PEG ratios (if it's below 1 it can be considered undervalued), and one of the lowest enterprise multiples, as well as the third-highest return on equity. Using these criteria we can see that Barrick is priced favorably against its competition. However, using price to book, it trades at a slight premium compared to most (although keep in mind Barrick has the most gold reserves).

Free Cash Flow

Another way to see how well Barrick is performing is by looking at its free cash flow. This is calculated by taking the operating cash flow and subtracting its capital expenditures.

During the past 6 months Barrick has had negative free cash flow due to a 36% increase in its capital expenditures over the same period last year. This is partly due to lower production than anticipated in Chile and Argentina, and so the company has increased its capital expenditures as a result. Historically however, Barrick Gold has had positive free cash flow, hitting a high of about $1 billion in 2006. This increase in expenditures should increase production so it shouldn't be too worrisome.

Future Growth of ABX Supports the Option Tip

Barrick Gold has targeted to grow to nine million ounces of gold per year within the next five years, up 15% from 2010. It is also lowering its cost per ounce to $290-$320 down from $340-$380 per ounce. It is priced favorably against the competition and increasingly has diversified into copper with the purchase of Equinox Minerals back in July. As long as gold prices hold up (and from the lack of supply coming onto the market and central banks still buying, it looks like it will for the foreseeable future), Barrick Gold is worth this option tip.

The Graph for the Option Tip

In the past 52 weeks, Barrick Gold share prices have been bracketed by a low of $42.50 and a high of $55.95 and are now at $47.60, 12% above that low price. Over the past week, the 200-day moving average (MA) has remained constant while the 50-day MA has declined 0.6%.

ABX-102611-graph



Potential upside of 43.4% exists for Barrick Gold, based on a current level of $47.60 and analysts' average consensus price target of $68.24. The stock should find initial resistance at its 200-day moving average (MA) of $48.83 and further resistance at its 50-day MA of $49.59.

Option Tip

Option Tip No. 1

A simple option strategy is to buy the ABX November 46 Calls for about $2.50

Or

Buy the ABX November 48 Calls for about $1.50

Option Tip No. 2

Based on the Barrick Gold Corporation's (ticker: ABX) current market price of $47.20 and using a target price of $49.00, a target date of January 20, 2012 and $1,000 of investment capital, below is an option strategy.

Buy ABX Call Fly

Profit at Target: $2,136.76

Probability of any Profit: 70.1%

Max Potential Loss: $992.00

The Strategy

Buy 8 of 21-Jan-2012 45 Calls

Sell 16 of 21-Jan-2012 50 Calls

Buy 8 of 21-Jan-2012 55 Calls

This is a non-directional strategy that expects minimal price movement in either direction by the target date. Similar to a short straddle, but risk is limited to the cost of the position.

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