by Bill Holter, Miles Franklin:
This article was posted for subscribers in early May. Now that gold is breaking out above the manmade, 6 year trading range, the concept is extremely important. Please reread the article until you understand what I am describing?
The Greatest Gold Call Option On The Planet?
Originally posted May 6th, 2019
If you have done your homework and concluded the financial world is on the precipice of a credit/currency meltdown, then you understand gold (and silver) is your safe haven. We at JSMineset posted a quote by Simon Mikhailovich six months ago and have left atop the homepage ever since.
If one offered investors a fat tail put option that never decays or expires, costs about -1% pa to carry, has no counter party risk & no chance of ever becoming worthless, there would be a line out the door. But when one explains that this option is physical gold… no interest.
– S. Mikhailovich
We did so because the quote is 100% correct. Gold is the ultimate put option versus an overlevered world. But how can you “leverage” your position in gold either offensively, or as a hedge defensively? Plainly, what is THE greatest gold call option on the planet? What follows is my opinion of what I would look for in seeking the greatest gold call option. Let’s look at the characteristics of a call option and apply them to gold.
The list of characteristics are as follows;
- First and most important, the option must have a direct and contractual connection to real physical gold, verifiable as to the existence of the physical gold. A paper contract “promising gold” will not cut it because the liability involved where you must rely on someone else’s performance. You want as direct a calin to physical gold as possible.
- The option must have leverage to the price of gold, meaning it must out perform gold on the upside. The option must move in multiples to the upside when gold is moving higher.
- The option should have no expiration date.
- The option should never be allowed to be taken out (sold) from under you against your wishes. Its sale should be solely on your discretion and your timing.
- It must be liquid.
In the real world, what might this call option look like? Checking off the boxes from the above wish list, this option can only be a corporation because corporations have no date of death. They live forever unless they are bankrupted or taken over by another entity. In this instance, the call option would have no decay of premium or “time value” because there is no expiration date.
The company would also need to be chartered in a jurisdiction where a takeover attempt is extremely difficult. In Canada for example, it is extremely hard to take over a company in a hostile manner because before the process is done, the suitor must effectively control and have the vote of 90% of outstanding shares. This is a tall order if management has any sizeable stake, impossible if management can count on 10% or more of the votes.
As for leverage, this option can only be a mining company with operating leverage to the price of gold. For instance, a company that can mine current gold of $1,300/oz at say $650, makes $650 per oz mined. But if gold doubles to $2,600, this same company will make $1,950 per oz. A doubling of price creates three times the profit! The gearing is obviously much higher if the company is a high cost producer. For instance, a producer with a cost of $1,200 per ounce only makes $100 profit if it sells product for $1,300, but will make $1,400 per ounce if gold doubles. In this case, the option will have earnings at 14 times leverage to gold’s price.
This company must have proven and economically mineable reserves. Obviously the more reserves the better but the important part is the amount of ounces per share outstanding. The more proven gold per share, the better! It would also be helpful if this company not only has a lot of gold per share, but also has the future prospect of adding in many more gold ounces to their reserves by drilling and proving even more. Then, is there a “blue sky” factor? In other words, is there any prospect of finding more economically mineable gold,either deeper on the same property or on other properties owned? Lastly, is there even more gold but mineable only at higher prices? This is where the really crazy leverage comes in!
Maybe of greatest importance, where or what country does your reserve reside? Your property must be in a country with a rule of law and the threat of nationalization minimized. This threat can be minimalized in several manners. Is your contract with the host nation fair or is it imperialistic and not allow a fair share to the host? If imperialistc, the risk of nationalization is high. Along these lines, does or can the host nation have the know how and work force to efficiently mine the reserves? Or would their share of the reserves be enough to entice them to sit back and collect revenues knowing their take is higher than if they tried to mine the entire property on their own with picks and shovels?
Liquidity is also very important, I would desire a company listed on at least one major stock exchange. A major stock exchange in two different countries (or even more) would be ideal. Remember, as they say, “liquidity is only important when you need it”!
Lastly, and still under the rule of law category, is your mining company chartered in a jurisdiction that has an international treaty with the country where the reserves exist? This point is often overlooked but extremely important if conflict arises between the miner and the host nation. This is something many do not know, a treaty between nations is stronger than any business contract, not a minor point by any means.
Wrapping this up, the above is not 100% complete but enough of a boiler plate to be functional. Mining companies have been beaten down (many bankrupted) and for the most part forgotten since 2011. This should be expected because of the “leverage” described above. Leverage works both ways, up as well as down. Put mildly, current “entry” into any gold or silver resource/operation is about as cheap as any time in history…in other words, the downside is minimal because it’s already happened. The “it’s already happened” part is important because the next big move in gold and silver is up rather than down. The time to seek maximum leverage to gold WITHOUT using margin is here and now!