Barrick Gold Corporation (USA) (ABX), New Gold Inc. (USA) (NGD), Eldorado Gold Corp (USA) (EGO): How to Play the Spike in Gold

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It was a little over a month ago that gold was plunging, sending investors into a panic and driving gold miners’ share prices to new 52-week lows. This sell-off saw gold at a low of just over $1,200 per ounce with naysayers speculating that it would fall to under $1,000 per ounce.

What is the outlook for the price of gold?

Much of the speculation was based on the belief that the Fed would start tapering its quantitative easing program earlier than expected. This has artificially reduced interest rates near zero while injecting billions of dollars into the U.S. economy through a bond-buying program.

It was also based on better than expected economic data coming out of China and the U.S. But with the Fed now providing clearer guidance as to when and how that winding down will take place, much of the panic has subsided.

This, combined with growing civil unrest in the Middle East, has caused gold prices to spike, now up by almost 8% to around $1,415 per ounce for August. Gold mining stocks have made a sharp comeback over the last two weeks as a result. However, there is still considerable uncertainty as to whether this is a sustainable rally or a short-term price spike driven by geopolitical events.

Regardless of the short-term direction of gold, there are a range of factors that indicate a price floor has been created. And that’s because gold supply will fall with the majority of miners having slashed exploration and development programs during the second quarter of 2013.

While central bank buying is uncertain, there is still strong demand for jewelry, gold bullion, and coin investment. In the second quarter of 2013, jewelry demand climbed 37%, while gold bar and coin investment soared by 78% year over year. Despite the rise in the price of gold and the rally among mining stocks, the group has underperformed due to rising crude prices.

This is because gold miners are stocks first and a leveraged play on gold second, with gold mining being an energy-intensive activity. Accordingly the cost base of gold miners increases as energy costs rise. For August alone, crude rose 3% to well over $100 per barrel. Given the energy-intensive nature of gold exploration, mine development, and gold production, this has caused production costs to rise.

Barrick Gold Corporation (USA) (NYSE:ABX)

How to play the spike in the price of gold

The best way for investors to play the spike in gold and the ongoing uncertainty facing gold miners is to identify those miners that are undervalued, with a low production cost per ounce of gold. Typically, the highest-cost gold miners are those that are reliant primarily on underground mines to produce gold, while open cut mining is far more cost effective.

The world’s largest miner, Barrick Gold Corporation (USA) (NYSE:ABX) is one of the lowest-cost producers in the industry with an all in sustaining cost of $919 per ounce of gold produced.  For the second quarter 2013, Barrick reported particularly disappointing results, but this was to be expected by investors because of the difficult operating environment. It also slashed its dividend by 75% further disappointing investors and driving a sustained sell-off of its shares.

This has made Barrick Gold Corporation (USA) (NYSE:ABX)’s valuation appear quite appealing, with it now trading wiith an enterprise-value of only four times its EBITDA. But impressively for the same period Barrick grewe its gold production by 4%, leaving Barrick well positioned to take advantage of any increases in the price of gold.

Furthermore, Barrick Gold Corporation (USA) (NYSE:ABX) cleared the decks by taking a $5 billion charge against the value of its troubled Pascua-Lama mine, and commenced the divestment of a range of non-core assets. This leaves it well positioned to focus on its core gold producing assets so it can build value for investors.

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