Mining Gold Mining Results

Digging through Barrick Gold's latest gold-mining data & results...

IT'S GOLD WEEK for us here at HardAssetsInvestor.com, writes Julian Murdoch for HAI, so let's take a look at a company that pulls the shiny stuff out of the ground.

It happens to be one of the biggest players in this space, and it happens to have reported earnings this past Friday – Barrick Gold Corp (NYSE: ABX).

Why look at a gold company if you are a commodity investor? It all depends on how you like to play. There are advantages and disadvantages to pick-and-shovel plays vs. the metal itself, pros and cons we discussed in Gold vs. Miners late in 2008.

One of the interesting ratios we looked at was the Gold Price compared with the value of the Amex Gold Miners Index (GDM). It's worth tracking this ratio of gold against Gold Mining stocks over time.

Back in October – when Gold Prices were in the $750 range, and the Amex Gold Miners Index was sitting around 500 – the ratio of Gold Prices to the value of the Amex Gold Miners Index was above 1.5, a high number historically, implying that gold miners were cheaper than they'd been in years.

The picture has changed a bit now.

The ratio is currently playing much closer to 1-to-1. Because even though gold has climbed to $1,000 an ounce, before slipping back, Gold Mining companies' stock prices have risen too, sending the GDM climbing to similar levels.

With that in mind, let's look at Barrick...

Like many stocks in many sectors of the economy, Barrick has suffered tremendous swings of late.

After big drop-offs in June, August and September last year, the stock bounced back a healthy 78.4% from the low of $18.14 hit on October 27, 2008.

But even with that jump, last Wednesday's closing price of $32.36 was still almost 40% lower than its 52-week high of $53.55. And that downward spiral you see at the end of the chart? That's just Barrick dropping along with the rest of the market.

Last Friday, Barrick announced earnings that beat analyst estimates by 1 to 2 cents a share. But that success was dwarfed by one-time charges, which pulled the fourth-quarter results into the loss column.

The reason behind the success in earnings was more complex than just higher priced Gold Bullion. Remember, Barrick Gold Corp. is not a pure gold play – no matter what its name says. Yes, it does do the majority of its business in gold, but it also plays in the industrial metal markets with its copper production.

Perhaps more importantly, Barrick employs a disparate hedging strategy. It now avoids hedging its gold output in the Gold Futures market – a strategy used throughout the 1990s bear market by most major miners to defend against the falling price of their product. But now Barrick continues to hedge copper as well as other non-gold assets, such as oil and its currency exposure (notably the Australian Dollar).

Since Barrick does not hedge its gold, one would expect to see its stock performance closely mirror that of Spot Gold in the open market – at least to some degree. And usually, it has.

But look at what has happened recently. Beyond the stock price taking a larger hit than gold, we can see points of divergence – most of all in the very recent past.

At the tail end of the chart above, Spot Gold rose, but Barrick's stock fell. It's a similar pattern, in abstraction, to what's happened throughout down cycles in the last year.

Whenever Gold Mining stocks take a serious plunge, Barrick goes with them, while gold itself stays relatively strong in comparison. Classic safe-haven behavior, with investors choosing metal over the management, credit-market and political risks facing producers.

But still, compare that to copper.

Clearly the market understands the copper hedge. Because Barrick reported taking in an average $3.06 per pound for copper during the fourth quarter, compared with an average copper spot price in the market of $1.79.

The hedge there worked to boost Barrick's income. Plus, Barrick managed to produce more copper than was expected. Both bright spots on the balance sheet.

For potential Gold Mining investors, however, weighing up the biggest gold stock of them all, we have this company that produces both gold and copper – metals that have very different roles in the economy. Gold is the flashy high-priced one with little industrial utility. Copper is the boring one, demanded by industry and thus exposed to the economic cycle. Both are affected by the state of the global economy, but in different ways.

So the obvious question for investors in Barrick is one of sensitivity: How exposed is Barrick to each metal? How exposed is the company to the ups and downs of the commodities it produces? It would seem to be an easy question to ask and answer, but if you are interested in this simple data, you have to wade through pages and pages of management discussion to find it.

In this case, it was on page 67 of 116 of Barrick's year-end report. It shows that, at least for 2008, copper – a market in decline – was simply more profitable than gold.

That's the beauty of locking in the right contract price by clever hedging. Interestingly though, copper's sales as a percentage of total sales was lower in 2008 than it was previously. In 2007, copper accounted for 21% of total sales. Meanwhile, gold has accounted for a larger percentage of total sales (by dollar amount). Gold was 79% of total sales in 2007 compared with 2008's 84%. That's the rising price of unhedged gold in action.

The breakdown of expenses between the two metals has remained largely stable, with copper accounting for roughly 11% of total expenses for both 2007 and 2008. And all told, Barrick in 2008 benefited from hedging copper prices while maintaining control of expenses in a big way. At the same time, Barrick's unhedged gold operations were able to reap the rewards of higher prices.

In other words, they simply got it right.

It's worth pointing out, however, that these are operational figures, and when you spend your evening with their numbers, they can often seem buried underneath the weight of exploration, M&A activity, capital projects and the like.

So while Barrick had record cash flows from its core operations, it still reported negative financial earnings. And either way, the thing to remember when looking at big diversified commodity companies – especially mining companies – is that there really aren't any pure-play companies.

The big Gold Mining companies have multiple products that they are producing alongside, and it pays to look closely at how much of each they are pulling out of the ground and where their profits are coming from. It may turn out that the company you are looking at for gold exposure isn't as exposed as you would like. For more of a pure-play option, you'd have to look at true junior miners – a topic for another day, and a risky proposition in any economic climate.