The popular Robert Frost poem is a great reminder that financial rallies cannot be sustained indefinitely, especially in the resource sector. About a year ago the price for one ounce of gold was about $1,800. Today that same piece is only worth about $1,300. As a result the world’s largest gold company, Barrick Gold Corp, lost half of it’s value over the last 12 month period. The stock price went from $38 in June 2012, to $17 today, ouch. I’m not an ABX investor (not yet anyway,) but I feelz for its shareholders 🙁
Recently the Canadian giant revealed some bad news. Barrick announced plans to eliminate 100 jobs at its corporate headquarters in Toronto. 100 people may not sound like a lot considering Barrick employs roughly 25,000 total employees worldwide, but it represents about 25% of it’s corporate work force. At least the impacted employees will receive severance packages and access to career placement services 😀
It’s not only Barrick that’s facing the pressure. Earlier this month, US gold producer Newmont announced that it would cut its workforce at its home base in Denver, Colorado, by at least 33%. And Australia gold producer Newcrest said it would write down its asset values by about $6 billion.
The reason why gold companies are under-performing is easy to understand. It usually costs between $800 to $1200 to extract one ounce of gold from the ground. The spot price of gold as of June 25th is $1275. This means that some mines could be only generating just $75 of profit per ounce.
Last year Barrick produced about 7 million ounces of gold with all its mines combined. At $75 profit per ounce they would make about half a billion dollars per year. The question is what if gold loses even more value? Well if gold drops down to $1,000 an ounce, which some experts say might happen, and stays that way for a long time, then some mining companies will inevitably go bankrupt because their revenue wouldn’t cover the cost of mining anymore. But if gold goes back over $1,600 an ounce like in 2011 or 2012, then each ounce companies mine and sell will equal a profit of $400, instead of $75, assuming the same $1,200/oz extraction cost as before. That’s over 400% more profits 🙂 Would you pay $50 for a Barrick share if it will quintuple it’s profits? Many people would, including myself, hah. That’s a huge reason to like gold companies. An incremental increase in the underlying commodity price is an exponential leap in profitability and shareholder value 😀 But we just have to remember that the opposite is also true when gold price is moving in the other direction.
I think this recent drop in the price of gold is a great opportunity to start looking at some cheap gold companies. Barrick, Goldcorp, Newmont, and other major players have the money to withstand $1,000/oz gold and can weather the storm and come out on top because they’re the market leaders. This means that eventually they will easily be worth twice as much as they are are today. I wouldn’t want to miss out on this kind of opportunity 🙂 But don’t start buying ABX, or G, just yet because gold could get even cheaper. The best action to take right now is to watch the price of gold and look for positive indicators. Then start to invest in these companies after gold prices have increased for at least 4 weeks in a row and is 10% to 15% higher from its lowest point. I’ll write another post when that happens 🙂