Barrick v. Bullion

I sold off all of my Barrick shares today. I got a price of $35.50, which is far above the $20 and change that I bought them for. They have served me well. Given how passionate I am about gold investing, some readers may take this as a bit of a surprise. It’s not that I don’t expect the price of Barrick shares to rise longterm, because I do. I expect that all of the money bring forced into the system by its would-be saviors, the Federal Government and the Fed, are going to cause run away inflation that will force the price of many things higher, particularly gold shares.

However, since this inflationary scenario has not yet unfolded, I have to make the most profitable decision I can given the information I have at hand. Currently, analysts expect Barrick to be $1.75 a share for 2009 and $1.80 a share for 2010. With the company trading at $35.50, that works out to a Price-to-Earnings ratio of 20 or so. That’s a PE ratio that’s not as bad as the stock market at large (the Dow Jones Industrials are currently trading at a PE of 43.1 and the S&P at a PE of 62!) Of course, for Barrick, a lot is going to depend on the price of gold itself. Today, gold closed at $925 an ounce.

When Barrick was providing their guidance for 2009, they assumed an average price per ounce of $900, and so far that estimate has been pretty good. However, as the price of gold rose this year, the price of Barrick did not race ahead as you would expect. When the Comex price of gold rose to top $1000 an ounce in late February, the price of Barrick shares were largely unchanged as can be seen in the chart below.

The value of Barrick shares then declined rather dramatically (from close to $40 a share to $27 a share) in comparison to gold’s fall of only 10 to 15% over that same period. I feel that the value of gold bullion is a better short to mid term investment than that of the shares of Barrick. The lowest that gold has fallen on Comex has been to $860 or so, which represents only a 7% drop from its current price. If Barrick were to fall back to the neighborhood of $27 a share, that would represent a 22% drop from its current price. So gold seems the safer play here.

In terms of the upside, gold could easily go back to challenge $1000 an ounce and maybe push beyond. That would represent a rise of 8%. If Barrick were to return to its recent high of close to $40, that would represent a rise of 14%. Barrick does stand to show more upside potential in a rising gold market (as one would expect) but not a dramatically higher rate of return. And given the rather modest downside of gold bullion compared to Barrick, I feel the proper risk-adjusted play is to favor the metal over the miner.

Put another way, Barrick shares currently seem to be anticipating a higher gold price. Were that price to be realized, I’m not sure that Barrick would show much appreciation over its current share price since the its PE had already factored in a higher price for bullion. That again suggests that bullion owners stand to show more profit potential that Barrick shareholders.

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