Gold loses lustre

So Peter Munk is frustrated with the stock performance of Barrick Gold, the mining colossus that he created. Join the club! Hundreds of thousands of investors feel the same way.

Mr. Munk, the billionaire chairman of the world’s largest gold producer, praised the company at the recent annual general meeting (AGM), lauding management for “exceptional performance” and citing Barrick’s “great fundamentals”.

“For God’s sake, the world should be at your feet,” he told the managerial team. “What more can you ask for?”

A higher share price, that’s what. On the same day that Mr. Munk was extolling Barrick’s results, the stock dropped $1.09. It followed that with a further pull-back of $1.28 the next day, reaching a new 52-week low in the process. As I write, the stock is down 18 per cent from $46.15, where it began the year. The shares trade in Toronto and New York under the symbol ABX.

On the surface, it’s difficult to understand what the market is thinking. The company released first-quarter results on the same day as the AGM and they came in close to expectations. Net earnings were $1.03 billion ($1.03 per share), a 3 per cent increase from the year before (note that Barrick reports in U.S. dollars). Adjusted net earnings, with one-time items removed, were $1.09 billion ($1.09 per share), an 8 per cent increase from same prior year period. EBITDA was up 9 per cent to $2 billion however adjusted operating cash flow was off, coming in at $1.37 billion compared to $1.44 billion last year.

Barrick maintained its full year 2012 gold production guidance of 7.3-7.8 million ounces at total cash costs of $520-$560 per ounce and net cash costs of $400-$450 per ounce. The company expects copper production this year of 550-600 million pounds at cash costs of $1.90-$2.20 per pound.

In an effort to add to the attractiveness of the stock, the company raised its dividend by one-third to $0.20 per quarter ($0.80 annually). Based on what happened to the share price, investors were not impressed.

Barrick isn’t the only gold stock that is being hammered. Goldcorp (TSX: G, NYSE: GG) also hit a new 52-week low recently. It’s off 27.6 per cent since its 2012 opening price of $45.21.

However, in Goldcorp’s case the sell-off is more understandable. The company’s first-quarter results, which were released on April 25, were disappointing. Net earnings were $479 million or $0.51 a share, fully diluted (Goldcorp also reports in U.S. currency) compared to $651 million ($0.81 per share) in the first quarter of 2011. Revenue increased by almost 11 per cent to $1.35 billion but that was more than offset by a big increase in production costs.

CEO Chuck Jeannes blamed “adverse ground conditions” at the company’s Red Lake mine for delaying the development of new mining faces. “Taken together with lower grade in other areas of the mine, (this) led to our slow start to 2012,” he said.

What is especially ironic about the plunge in the price of the two gold mining giants is that the metal itself is up about 2 per cent since the start of the year, when it was trading at US$1,566.80 per ounce. This disconnect isn’t new, but it seems to be gaining momentum. There have been many theories as to why this is happening but in the end it seems to come down to investor scepticism over the future direction of the price of bullion, which will directly impact the bottom lines of the producers.

And why this scepticism? I suggest it is because of the gradual (very gradual!) improvement in the U.S. economy. Although the correlation is not perfect by any means, there has been a tendency in the past few years for the price of gold to move inversely to the value of the U.S. dollar. When the greenback declines in international currency markets, gold gains ground. The reverse occurs, bullion drops. A stronger U.S. economy, or the kind of flight to the safety of U.S. Treasuries that we saw once again this month, will tend to boost the value of the currency.

So far this year, the greenback has shown a very choppy pattern when measured against a basket of currencies that includes the euro, yen, pound sterling, Swiss franc, and Canadian dollar. But recently it has been in a rally mode and gold has been pulling back accordingly. (View a U.S. dollar chart.) If that trend continues, we could see bullion pull back to around US$1,550, which would be bad news for the stocks.

It’s interesting to note that the gold price does not seem to react to crisis situations as it has in the past. The European situation appears to be deteriorating further. Elections in France and Greece have created even more political uncertainty, unemployment is the highest it has ever been since the eurozone was created, and Germany, the continent’s economic engine, is teetering on the edge of recession. Yet gold doesn’t seem to care.

None of this bodes well for the near-term outlook for gold mining stocks. However, prices are now at levels where the strongest companies, such as Barrick, look increasingly attractive to those with a longer-term perspective. With the yield now up to 2.1 per cent based on the enhanced dividend, the stock certainly merits a close look. Ask a financial advisor if the shares are appropriate to your needs.

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