Gold mining is a tough business. It is capital intensive to get that precious yellow metal out of the ground, and then the price that can be fetched on the open market can vary greatly. In the past several weeks the price of gold has dropped dramatically, while the price of many gold miners has dropped even more. Because of the uncertain and capital-intensive business model, gold miners are not high on the list of stocks that I generally watch. However, the massive price drop has gotten my attention: the risk of any stock is inversely proportional to the price you pay for it, and gold miners have just gotten a whole lot cheaper. Now of course momentum in the market can take a while to reverse itself, so the prices of these stocks may have a good deal further to fall.
That being said, it is worth analyzing several of the stocks and carefully weighing the pros and cons of the investment thesis in order to be able to capitalize on the market’s risk aversion to gold stocks. If you believe in the fundamentals of the yellow metal this may be a golden buying opportunity.
Figure 1: The Price Performance of Gold and Several Gold Miners
The stock with the best price performance over the past five years is Randgold Resources Ltd. (ADR) (NASDAQ:GOLD). The stock is probably the highest risk due to its concentration of mining operations in Mali, which adds political risk to the previously mentioned risks inherent in gold mining stocks. The stock is the most expensive in terms of price/book and price/sales, but it has also demonstrated the most impressive growth over the past decade. Sales and net income have grown at a 35.3% and 34.2% CAGR, respectively, over the past nine years. If you are interested in a growth stock here, Randgold Resources Ltd. (ADR) (NASDAQ:GOLD) may be your first choice.
Barrick Gold Corporation (USA) (NYSE:ABX) is the cheapest of the bunch with a price to book of 0.92 and price/sales of 1.56. It also sports the highest quantity of proven gold reserves compared to its market cap. As I write this gold has a spot price of $1477/oz., meaning that Barrick Gold Corporation (USA) (NYSE:ABX)’s reserves have a value of $206.7 billion. The price to mine those reserves comes between $600 and $700/oz., so it is fairly easy to rationalize the price of Barrick based on its gold reserves alone. That being said, costs have spiraled out of control and the company is no longer profitable, thus an investment in Barrick Gold Corporation (USA) (NYSE:ABX) requires no small degree of faith that the company can successfully manage its costs and regain profitability.
Yamana Gold Inc. (USA) (NYSE:AUY) has demonstrated fairly impressive growth over the past ten years, and its share price has declined the least of the bunch over the trailing 12-month period (-11.7%). The company has also managed its costs well, but sports the highest TTM P/E. Unfortunately it is not as undervalued based on discounted cash flow, and a clear picture of its proven reserves could not be obtained from either analyst stock reports or its annual report.
Goldcorp Inc. (USA) (NYSE:GG) now sports the largest market capitalization of the group, even with significantly lower reserves. It does not seem sufficiently undervalued given the deterioration of gold mining fundamentals. Finally, Newmont Mining Corp (NYSE:NEM) seems to be the most solid pick among the bunch. The company has managed its costs well and retained profitability in a challenging environment. It has the highest dividend yield of the group at 4.40%, which is well above the average dividend yield for the past ten years. It is well undervalued compared to its proven reserves, and while it has not grown sales at the extent of some of the more growth oriented gold mining stocks, it has still grown its net income by a CAGR of 47.0% over the prior nine-year period.
Newmont Mining Corp (NYSE:NEM) is coming close to crossing below its book value. Over the past ten years Newmont has grown its book value from 5.80 billion to 16.95 billion, a CAGR of approximately 12%. In the past 10 years the firm has traded at an average price/book of 2.10. If Newmont Mining Corp (NYSE:NEM) is able to continue its growth of book value and if its price/book reverts to the mean within 10 years, investor today can expect a 19% CAGR in addition to the firm's 4.4% dividend yield. While these assumptions may be overly optimistic, it is hard to imagine Newmont lagging the market by much over a prolonged stretch of time.
Newmont has been aggressive at controlling its costs. As can be seen from the chart below the last time that revenue declined was in 2008. During that period Newmont aggressively cut costs from 7.78 billion in Q1 2008 to 5.67 billion in Q2. The stock bottomed well before the rest of the market in this period and rebounded sharply by the end of 2008. Based on this historical precident, I expect that unless the price of gold declines significantly from here Newmont should maintain its earnings around 1.81 billion, which is about what the First Call earnings consensus expects. Given the negative momentum of gold mining stocks it is expected that the price will decline further yet; however, if you are constructive on the fundamentals of the gold mining industry this should present a buying opportunity for Newmont somewhere in the low $30/share range.
Figure 2: Newmont - Lower Costs and Rising Net Income Seem to Bode Well for the Stock
As can be seen over the past ten years gold mining stocks in general have not made spectacular long term investments. However, one can be reasonably certain that the yellow metal will retain its value. Buying and holding gold mining stocks may not earn you a golden return, but buying at a low enough price will probably be as good as gold. Newmont is becoming very cheap and the overall business model seems to be in little jeopardy. Getting paid a 4.4% dividend while you for the price to rebound doesn’t seem like a bad deal either.
Brendan O'Boyle has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.