Once in a Lifetime Opportunity to Buy Barrick Gold!

John is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Baron Rothschild, who made a fortune after Napoleon was defeated at Waterloo, is credited with the saying: “The time to buy is when there is blood in the streets.” In more recent times, Warren Buffett expressed a similar sentiment when he opined: “Be greedy when others are fearful.” These snippets of market wisdom have never been truer than now when you consider the total collapse of gold mining stocks. In my opinion, we currently have a once-in-a-lifetime buying opportunity to purchase Barrick Gold at an incredible discount.

The cost of an ounce of gold

Over time, the cost of mining gold has risen because of increased costs of labor, materials, and energy. In addition, most high grade ore has already been mined so miners must now extract gold from lower grades, which is more expensive. There are two ways to measure the cost of recovering one ounce of gold. The first is the cash cost which is just the operational costs of mining. A better measure is called the “all in cost,” which takes into account the mining costs plus refining, administration, taxes, royalties, etc. The all-in costs are generally about 50% higher than the cash costs.

The all-in costs for the three largest gold mines are projected from their annual reports as:

  • Barrick Gold (NYSE: ABX): $950 to $1025 per ounce
  • Newmont Mining (NYSE: NEM): $1100 to $1200 per ounce
  • Goldcorp (NYSE: GG): $1000 to $1100 per ounce

Gold is searching for a bottom

These all-in costs are important because this week gold dipped below the $1200 per ounce level for the first time since 2009, which is getting very close to the all-in costs. If the price of bullion does not recover, then some of the higher priced mines will become unprofitable and will be taken offline. This will sharply reduce supply and should cause the price of bullion to rebound. So my Foolish belief is that the price of gold bullion is finally bottoming and, if true, this is excellent news for the mining stocks.

Since last October, the price of gold bullion has cratered over 25%. In the same timeframe, both GG and NEM have declined 36% but ABX has crashed by almost 60%! Why did one of the world’s largest gold miners, with the cheapest all-in costs, collapse so much more than the other, more expensive mining companies? The answer is two words: Pascua-Lama.

The reason behind Barrick’s fall

Pascua-Lama is a gold mine in the Andes Mountains on the border of Chile and Argentina. It sits at over 14,000 feet above sea level on top an estimated 17 million ounces of gold and 635 million ounces of silver, with about 75% of the deposits on the Chilean side. When completed this will be one of the world’s cheapest sources of gold but the construction is about 2 years behind schedule (now projecting a 2016 completion) and is substantially over cost (now projected to be $8.5 billion rather than the original estimate of $3 billion).

However, the most pressing issue is that construction has been stopped by the Chilean government due to some environmental issues (the site is near 3 glaciers). It is not clear when these issues will be resolved but this is an important project for Chile as well as Barrick so I expect that an accommodation will be reached later this year. When this stoppage was announced in April, Barrick fell hard from around $30 per share to under $20 in a few days and has yet to recovery (current price is less than $16 per share).

Compelling metrics

In virtually every value metric, Barrick shines when compared with its peers. Barrick’s forward Price-to-Earnings (P/E) ratio is extremely low at 4.9 and is significantly lower than Newmont (9.3) and Goldcorp (12.4). In terms of price-to-book, Barrick comes in at a compelling 0.7 compared with 1.1 for Newmont and 0.9 for Goldcorp. Perhaps one of the best metrics is the dividend yield. Barrick is now paying over 5% which is higher than Newmont and much higher the Goldcorp. So Barrick will pay you to wait for improvement in the Pascua-Lama situation.

Based on the above analysis, I believe the recent decline of Barrick was overdone. Pascua-Lama is important to Barrick’s future, but it is not a make-or-break proposition. Even without Pascua-Lama, Barrick owns over 26 mines that produced over 7 million ounces of gold last year. Barrick also has over 120 million ounces of gold and about a billion ounces of silver in reserves.

Foolish bottom line

When the Pascua-Lama issue is resolved, Barrick should rocket ahead, but until then, the company is one of Wall Street’s most unloved stocks! Thus, based on the old Wall Street adage, it may be time for Foolish investors to back up the truck and load up with this gold stock. If you can handle the volatility, then I believe that long-term investments in Barrick will be well rewarded.

John Dowdee has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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