Stock Alert: Time to Shove All-In on Barrick Gold

The Stock Market is full of strangely priced equities. The things that most often make the news are the stocks that are trading far above any rational price. With most banks offering interest rates on savings far less than the government’s own rate of inflation (with a “real” return of -4% or so) you would think that hot money would be flooding into the stock market in search of bargains. So stocks like Barrick Gold (ticker symbol: ABX) and the other gold miners has been an ever increasing mystery to me.

To illustrate my point, I did some very rough eyeball calculations of roughly where the share price of Barrick was compared to where the price of gold bullion was for a given year. Here, that a look at this data and see if you can make heads or tails of it:

2006 2007 2008 2009 2010 Q2 of 2011
Gold Bullion $625 $700 $825 $900 $1200 $1600
Shares of Barrick $30 $37 $45 $35 $48 $47
ABX PE Ratio 22 32 24 17 13 10

The earnings per share used to calculate the PE ratios came right out of Barrick’s Year End Statements or, for 2011, the statement for the second quarter. Note that for 2009, Barrick took a big charge to eliminate it’s forward seeing gold contracts, and so I was using pro forma earnings for that year. So let’s see what the data tells us.

Well it’s no surprise to anyone that gold bullion is going gang busters. For that matter, with the way the American government is spending money, no one’s really expecting it to stop anytime soon. So the stock market should absolutely love gold miners, as the increase in gold’s price translates leads to an amplification of profit’s in excess of percentage rise of gold itself. How amplified you ask, well over the years cover by this chart, bullion has risen from $625 to $1600- an increase of roughly 250%. Meanwhile, the earnings per share of Barrick has increased from roughly $1.39 to $4.64- an increase of roughly 334%.

So Barrick the company has been performing a bit like you would expect in bull market in gold; it’s earnings have gone up tremendously. Barrick the stock, however, has not done at all as you would expect for a company in a bull market in gold; it’s share price has gone up roughly 30% or so while it’s underlying earning’s have almost quintupled. Furthermore, given that all systems appear go for gold’s continued climb, future earnings should continue to grow which is what the stock market is usually factoring into the share price of companies to make them so lofty.

So what gives? Well it’s hard to say. Nothing in the company’s investor relations gives any reason for it’s stock performance. So it would seem the company is as baffled as we are. I did, however, read something in gold investing newsletter that does shed some light on this situation, and that’s that hedge fund managers like to be long on gold bullion but short on the stock of gold miners. They are “hedge funds” after all. They are supposed to “hedge” their bets.

If they are long gold bullion and the bullion market continues, then all is well. However, what if the market for gold goes down for some reason? Well, to protect against that, they take out shorts on the mining stocks figuring that a decrease in gold price would lead to an amplified decrease in the share price of the miners. So, they figure, they’re covered in case of a decline.

In one respect, they are correct. They are covered against a decline in gold bullion prices. However, what they are not covered against in a continued increase in gold bullion because, it SHOULD result in a far greater increase in the price of the miner’s shares. Were that to happen, whatever profits they would have realized in their bullion positions would be more than reduced by the shorts on the miner’s shares. So this position doesn’t make sense to me from an investing point of view. But, then again, hedge funds never made much sense to me from an investing point of view.

Hedge fund managers tend to be a bit of a herd. So if their competitors are doing it and it’s working for them, then they’ll want to get in on the action. This kind of herd behavior will work right up until it doesn’t. So, long story short, this to me represents a tremendous investment opportunity in Barrick gold. The stock of Barrick could be trading at four times the share price it currently commands. So that’s an investment with little downside and a great upside. I’ve been a longtime owner of this stock, but recently I’ve been selling my other positions to really load up on Barrck shares. It’s time to shove all in.

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