Gold Miners Show Signs of Recovery

 | Mar 22, 2013 | 1:00 PM EDT
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Gold-mining stocks have been a black hole for investors over the last 18 months or so. Falling gold prices, cost overruns on expansion projects, major strikes in South Africa and inflation in operating expenses have combined to make the sector once of worst performers over the last year and a half.

Simply put, mining companies were too aggressive in expanding when the price of gold was shooting to $2,000 an ounce and were not diligent enough in controlling costs. Mining stocks have made several false starts over this dismal period, but no rally has been sustained.

I believe this is going to change in the near future. Many mining companies have jettisoned poorly performing CEOs and curtailed their expansion plans, and there is even starting to be talk of unbundling the major gold miners to unlock shareholder value. Such a move would mimic the very successful strategy that several integrated oil majors -- ConocoPhillips (COP) for example -- have used recently, creating shareholder value by spinning off their refinery operations. The gold-mining sector also seems to staging a possible reversal over the last few trading sessions. I do not know if this is the start of a recovery after a horrid two years, but it feels like it might be.

Gold Miners' Performance
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Here are two gold-mining stocks that look undervalued here, and here's how to play them with option spreads to maximize reward and minimize risk

Gold Fields (GFI): This gold miner has operating mines in Africa, Peru and Australia. It spun off most of its South African assets in February. JPMorgan immediately upgraded the remaining company as an Outperform, as the spinoff will allow management to focus on growing production at existing, stable properties. At just over $8 a share, the stock is cheap at just over book value and under 6x 2014's projected earnings. Analysts expect revenue to increase 18% in 2013, and Gold Fields also yields 1.8%.

Newmont Mining (NEM): The company is one of the largest gold miners in the world, and it also produces copper. The stock trades at just over $41 a share and was over $55 a share as recently as the fourth quarter. The stock yields over 4%, and that puts a nice floor under the stock. It is also cheap at just over 8x 2014's projected earnings.

The gold-mining sector is very cheap on most valuation metrics, and this could be an inflection point before a major rally. However, as stated in the opening, this sector has had many false starts in the past. Since volatility and option premiums are so low right now, the way to play the sector is to buy out-of-the-money bull call spreads. If the sector is at a start of a large rally, an investor should be able to book substantial gains. If this knife continues to fall, risk is minimized. It is the way I am playing this possible turnaround.

Here are two bull market call spreads I like here. The GFI Jan 14 $10/$15 call pair can be had for around $0.70 per bull call spread. The NEM Jan 15 $50/$60 call pair is around $1.60 per bull call spread.

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