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Golden LeverageRalph Kettell We are in the midst of a monumental bull market in precious metals, particularly gold. If you look only at gold as denominated in the US dollar, the bull began in the 2nd quarter of 2001. If instead you look at gold's value relative to a basket of international currencies, you will find that in fact gold has been in a bull market since the end of the 3rd quarter of 1999. If you concur with my assessment of the gold market situation, then you probably have or are in the process of deploying a portion of your investment capital to profit from the continuing rise in the price of gold. As I have a limited supply of capital, I often search for opportunities to safely leverage the returns that I can achieve investing that capital. I have discovered several great ways of leveraging my capital in the gold market over the past two years and last week I found one more. I was reading Jay Taylor's article on Kimber Resources at 321gold. I am acquainted with the company, but up until now had not purchased any of their stock. I own shares in so many great gold mining/exploration companies that Kimber had just not climbed to the top of the pile and been purchased; impressed though I was/am with their prospects and their management. Upon further research, I found that Kimber had free trading warrants. The Kimber warrants were from a financing which completed on July 12th of 2002. They have an exercise price of Cdn$0.55 and expire on January 12th, 2004. As of Monday morning, May 12, 2003, the warrants, stock symbol KBR_t.V were trading at 0.055 bid by 0.07 ask. The underlying Kimber stock, KBR.V, was trading 0.49 by 0.51. In essence this is a long term (8 months) Call option which is 5 cents out of the money that you could buy for 7 cents. I decided to compute the potential gains if I were to buy the warrants and to find at what stock price the warrant profits overtake the stock profits. Warrants are a wasting asset which means that they have time value which disappears as the expiration date approaches. Therefore, if the underlying stock does not go up a sufficient amount, they will expire worthless. However, they are leveraged which means at some price of the underlying stock the appreciation (in percentage terms) of the warrants will blast past the appreciation of the stock. The following table shows that this crossover occurs just under 0.64 or an appreciation of 28%.
So the table above shows that for any price of Kimber stock less than $Cdn 0.55, the warrant investment is a total loss. At a stock price of $0.64, the profits in the warrants and stock are about the same or 26%, but above that price the warrants get very, very interesting indeed. If Kimber common stock goes up 50% from where it is today, the warrants will give a 186% profit, and it doesn't take much to have a gold mining/exploration stock go up 50%. The potential returns are huge. I have included a graph below which plots the profit potential of both the stock and the warrants and also the intrinsic value of the warrants relative to the underlying stock.
The returns for the warrants of 2000% at the right side of the graph are not at all out of the question. Many exploration stocks like Kimber went up 300% and more in last years gold stock run up. Who knows they may go up even more in this years run up? Using Jay Taylor's rule of thumbs, I wouldn't commit more than 5% of your portfolio to any one stock and as this is riskier than the underlying stock you might want to limit it to 2% to 3% or less. It seems to me to have great potential, so I have purchased a small position this morning. I reran the
simulation for a slightly higher price for the warrants, which
could happen if Kimber continues to go up. I guessed that when
the stock reaches parity with the warrants exercise price of
0.55 the warrants might be asking 0.10 and I ran the simulation
with these numbers. The returns, while not as phenomenal as the
first simulation show that the returns would still be quite healthy.
Disclosure: Disclaimer: |
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