Why to Avoid Barrick Gold

Source: Thinkstock

Source: Thinkstock

Barrick Gold (NYSE:ABX) is the world’s largest gold mining company. Last year it produced nearly 7 million ounces of gold, and this year that number should decline slightly, but it will still exceed the production figures from every other gold miner in the world. Meanwhile Barrick has been a lousy investment. It has substantially underperformed the price of gold over long periods of time. In fact since the SPDR Gold Trust (NYSEARCA:GLD)—the world’s largest gold ETF—began trading in November, 2004 Barrick shares are down 30 percent, whereas GLD shares are up a whopping 173 percent. Those investors who bought Barrick hoping for leverage to the gold price have been significantly disappointed, and shockingly they would have been better off in cash.

Barrick has had a history of making value-destroying acquisitions, investing in failed expansionary endeavors, and making lousy market bets that have led to this. For instance in 2011 the company acquired Equinox—a base metal company in Africa—that cost it billions in write-downs, thanks to the fact that management failed to do due diligence on the company. The company has dumped an enormous amount of capital into its Pascua Lama Project in Argentina and Chile that has been repeatedly postponed due to regulatory issues and an ever-rising initial capital expense estimate. Finally all throughout the first part of the gold bull market—that is, when gold was trading below $1,000/ounce—Barrick hedged its gold production. In other words the company was net short of gold.

These poor decisions led to a management shakeup late last year, as well as a secondary offering that added 30 percent to the share count. It also cut its dividend by 75 percent, although admittedly this was the norm for the industry. But so far the management shake-up and the secondary offering have had little effect. The company is now once again trying to put its seemingly hopeless Pascua Lama Project back on the path towards production instead of giving it up.

Furthermore, the company still has an incredible amount of debt that makes it extremely vulnerable to a fall in the gold price. While I am bullish of gold I also realize that it can trade down before it trade higher, and this can really hurt companies that have a lot of debt-related and other fixed expenses.

Finally, the company still has a lot of copper exposure, and copper, unlike gold, is an economically sensitive commodity that can fall in an economic recession while gold rises. Copper has fallen nearly 10 percent for the year while gold is up nearly 6 percent.

Thus, it doesn’t surprise me that Barrick Gold shares are down this year even though the rest of the gold mining sector is on the rise along with the gold price. Investors shouldn’t take this underperformance as a contrarian “buy” signal. Gold and the miners as a whole have had a contrarian “buy” signal for several months, and Barrick’s underperformance in this context tells me that even the contrarians aren’t interested.

Investors should avoid Barrick unless it does two things. The first is that it needs to simply drop Pascua Lama, or at the very least it needs to leave it alone until the gold price rises significantly from here. It is simply too much trouble for the time being, and it distracts from other issues. Second, it needs to pay down some of its debt. Ideally it will do this by selling some of its copper assets so that it is more gold-focused.

If the company focuses on gold and on financial stability then it can be a winner going forward, and it will attract gold mining investors. Otherwise it will continue to lag the sector.

Disclosure: Ben Kramer-Miller has no position in Barrick Gold.

More From Wall St. Cheat Sheet: