Buying Barrick Gold Ahead of China

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

The views of where the price of gold will finish 2012 are as wide-ranging as most hotly contested issues, each with supporting evidence and solid arguments. Given a climate of economic uncertainty, potential quantitative easing by the Federal Reserve, ongoing debt issues in Europe and politicians playing election-year politics, maintaining some exposure to gold is advisable. While prices for the commodity seem to have been range-bound between $1,550 and $1,650 for some time, the number of catalysts that could drives prices to significantly higher levels abound.

Separating Fact from Fiction

Gold, and subsequently gold stocks, seem to have the ability to cloud the minds of otherwise reasonable men and women. It is for this reason that before proceeding it is of the utmost importance to separate the facts from the fictions that have been circulating regarding the potential actions of Barrick Gold Corp. (NYSE: ABX). The company, along with its recently appointed CEO, announced that it is in talks with China National Gold Group Corp to sell a majority stake in African Barrick Gold Plc. The company as a whole is not an acquisition target of that company or of the Chinese government. If there are rumors to that effect, they have been started by analysts and bloggers that did not read carefully enough to get the facts sufficiently correct.

A New Direction for Barrick

News of the asset sale, despite the above confusion, is significant because it is a clear sign to investors that Jamie Sokalsky, the new CEO, means to carry out the vision he has announced to the world. In a recent statement, Mr. Sokalsky summarized this vision by saying, “Going forward, returns will drive production. Production will not drive returns.” To put the asset sale into even sharper focus, while the 7.7 million ounces of gold produced by the company in 2011 had an average cost of $460 per ounce, the per-ounce cost of the 509,000 ounces that came from African Barrick was $692. While it will take more than a new vision to restore faith in management to Barrick investors who have been stung by a 20 percent year-to-date decline in the stock, it may be a good first step.

The company, which had previously disclosed potential acquisition talks with rival Kinross Gold Corp. (NYSE: KGC), badly missed earnings in its early-August release; no further Kinross chatter has surfaced since the earnings miss. Highlighted in that report were dramatic cost overruns at the company’s Pascua-Lama mine. Where initial estimates had pegged the cost at $1.5 billion, new estimates inflated that number to near $8 billion. Mr. Sokalsky is not responsible for the overrun, but he is sending a message that the “growth at all cost,” referring to production capacity, edict that has marked the culture of the major miners for years is changing at Barrick. A more disciplined approach should ease the concerns of investors over time as the plan is put into place.

Why Choose Barrick?

If one accepts the need to maintain exposure to gold by owning a mining stock, the issue of which company to hold must still be addressed. Despite the earnings miss discussed above, Barrick continues to boast very favorable metrics relative to many of its peers. On a pure P/E basis, the stock is currently trading at an 8.8 multiple relative to 1010 for AngloGold Ashanti Ltd. (NYSE: AU) and 101.6 for Newmont Mining Inc. (NYSE: NEM). The company also has the best operating margin, despite cost problems, at 42%, compared to 32% for AngloGold, 38% for Newmont and 31% for Kinross. While Barrick’s competitors are solid companies, as Barrick already holds the position as the world’s largest producer by volume, meaning it can most afford to adopt a new culture of discipline over pure growth, it holds the superior position. Even when growth is included in the mix, and the companies’ relative PEG ratios are considered, Barrick stands at the head of the pack with a PEG of 0.11 relative to 0.13 for AngloGold, 0.16 for Newmont and 1.17 for Kinross.

Overview

The combination of Barrick’s solid metrics in spite of a recent earnings miss and the adoption of a new strategy of discipline make it the most attractive option amongst its peers. There are significant arguments that the price of gold is poised to reach higher levels by the end of the year. Maintaining exposure to the sector is, therefore, advisable and Barrick is the right stock for the job.


Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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. If you have questions about this post or the Fool’s blog network, click here for information.

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