Gold Cheat Sheet: One Stock to Buy and One to Avoid
Gold mining shares have performed terribly over the past couple of years. Since peaking in 2011, the Market Vectors Gold Miner ETF (GDX) has lost more than half of its value. Nevertheless, I think this is an excellent reason to consider investing in gold miners along with the fact that the fundamentals are very strong in the gold market. However, I don’t think it is a good idea to simply go out and buy the Market Vectors Gold Miner ETF. Investors need to realize that gold mining is an extremely difficult business. As a result, there is a bifurcation in the industry: some companies perform well while others do not. Investors should therefore single out those companies that have performed well and purchase them as opposed to a basket, which contains the bad with the good.
In what follows, I highlight one excellent gold miner – Randgold Resources (NASDAQ:GOLD) and juxtapose it with a poorly run company – Barrick Gold (NYSE:ABX). It will become clear why the former has succeeded while the latter has not, and it should become clear that investors would be wise to take the time to research individual companies in order to select the winners.
Randgold Resources has been one of the best performing gold mining companies in the 21st century. The company has an extremely simple yet disciplined strategy that goes beyond meaningless platitudes such as “growth” and “low cost production.” The first is that the company is focused on western Africa. While investors are often hesitant to invest in Africa, West Africa has been a relatively stable mining jurisdiction. Furthermore, it has a lot of unexplored land containing high grade gold deposits.
The second is that the company focuses on highly profitable assets. Randgold’s management is not interested in a project unless it believes that it can produce gold at a very low cost. This has probably reduced its growth rate on a per-ounce basis. But at the same time, the company didn’t have to write down any reserves in 2013 unlike its peers because it made extremely conservative price projections despite management’s long-term bullishness.
Finally, the company has had a very disciplined fiscal strategy. It has no debt and it has been very prudent in its acquisitions. These simple guiding principles have sent shares soaring a whopping 850 percent over the past 10 years. While the stock isn’t cheap, it isn’t incredibly expensive either, and it is positioned to continue to grow while offering leverage to the gold price.
Barrick Gold seems to be the exact opposite on each of these fronts, and it shows in the company’s stock performance, which is abysmal considering the strong gold price performance. Over the past 10 years the stock is actually down 10 percent! Let us see why.
First, we saw that Randgold focuses on a particular region. This enables it to specialize in this region. On the other hand, Barrick owns projects all over the world. While this is a good strategy from a diversification standpoint it shows a lack of discipline, and it follows that the top executives don’t have the intricate knowledge of the company’s 2 dozen projects that Randgold’s management has. It also invests in risky parts of the world such as eastern Africa and Argentina.
Second, for a long time the company had no parameters by which it determined projects to buy. It simply wanted to grow production. Thus, it owns high cost mines as well as low cost mine. While management has stated that it is changing this strategy we are not seeing cost-cutting and an emphasis on low cost assets in the bottom line. Furthermore, we saw recently that it sold some low cost, low risk assets to Gold Fields (GFI) in Australia. It also sold a JV project to Silver Standard Resources (NASDAQ:SSRI) after spending millions of dollars upgrading it. Thus, it is difficult to see the company’s asset selection strategy, and it is reflected in its poor performance.
Finally, the company has a lousy balance sheet with a lot of debt. It got so bad that last year the company had to dilute shareholders in order to pay some of it back. But the company’s debt load is still high at $13.2 billion. A high debt load increases the risk to investors if the gold price falls. It also adds to the company’s operating costs because it has to pay interest on its debt. This, in effect, increases the company’s production costs on a per-ounce basis.
The bottom line is that Barrick Gold has had lousy strategies and it has alienated the gold investment community. Randgold has done the opposite, and it is reflected in the company’s track record and stock price performance.
As we can see, it makes a huge difference which gold miners you buy and which you choose to avoid. By taking the extra time to parse them out you could have avoided a dead asset (Barrick) while buying an asset that generated incredible shareholder value with a conservative, disciplined strategy (Randgold.)
Disclosure: Ben Kramer-Miller is long Silver Standard Resources.