As bullish as I am on the price of gold and on gold mining companies, I think investors need to be very selective in choosing the latter. If the price of gold rises, this does not imply that every gold mining stock will rise as well. Many of these companies operate in dangerous parts of the world, carry high debt loads, invest in mediocre projects, and fail to take advantage of growth opportunities. As a result, it should come as no surprise that there are many gold mining stocks that substantially underperformed the gold price.
One company that has unfortunately satisfied all of these criteria is Barrick Gold (NYSE:ABX). Barrick is the world’s largest gold mining company. It mines more than 7 million ounces of gold annually all over the world, with its largest projects located in Nevada. Barrick’s stock price is up roughly 50 percent since the gold bull market began in 1999. While the stock is up, those who bought it hoping to benefit from and gain leverage to the rise in the gold price missed out on gold’s 400 percent price increase. There are many good reasons for this.
First, the company hedged a significant portion of its production until gold breached $1,000 per ounce in 2009. Thus, as the gold price was going up, not only was a portion of Barrick’s portfolio not benefitting, but it accumulated a massive — $5.6 billion — paper loss that had to be written down. While the term “hedging” is associated with risk mitigation and is viewed as a positive, it is evident that Barrick’s management failed to understand the economic factors driving the price of the commodity that it mines.
While the company no longer hedges, management doesn’t discuss the merits of owning gold and gold miners in its investor presentation, which is a practice that has been undertaken by many of the company’s peers. Given that I invest in gold miners because I believe that the gold price will rise and given that I invest in companies whose management teams have similar goals and beliefs, I cannot endorse an investment in Barrick given its lack of enthusiasm for the gold bull market.
Second, the company has made some lousy deals in the past few years. Most notably, it purchased Equinox — a copper company with a project in Africa — in 2011, only to come to the realization that the project is not worth nearly as much as it once thought. The $7.3 billion acquisition in 2011 was followed by a $4.4 billion write-down in 2012.
More recently, the company sold its Australian assets to Gold Fields (NYSE:GFI). These are profitable assets in a low-risk mining jurisdiction. Considering the political woes the company is facing in Chile and in Tanzania, I find it puzzling that the company would be so eager to unload relatively low-risk assets. These two deals lead me to question management’s stewardship of shareholder capital, and it makes me hesitant to invest.
Third, the company has a lousy balance sheet. At the end of the third quarter, the company had $15.4 billion in debt and $26.2 billion in total liabilities versus $13.6 billion in net equity. This situation has improved somewhat since then, but at a steep price. The company issued $3 billion worth of stock back in October, and it slashed its dividend by 75 percent. Despite these punitive measures, the company’s balance sheet is still in bad shape, and if the gold price weakens from here, Barrick can face serious problems.
All of these issues — past and present — lead me to the conclusion that I can find better opportunities in the gold mining sector. Nevertheless, investors should keep in mind that the stock may do very well if the gold price rises sharply, as the market is already aware of these issues. Consequently, I would avoid shorting Barrick shares at the current $19.25 per share price.
Investors should also note that Barrick is the largest holding in the Market Vectors Gold Miner ETF (NYSEARCA:GDX). Therefore, while I believe in diversifying one’s portfolio of mining stocks, I don’t think owning GDX shares is a good way of achieving this. Instead, investors should look for gold miners that have clean balance sheets, low production costs, and a history of growth.
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