Portfolio Review: Barrick Gold

“Inflation is always and everywhere a monetary phenomenon” — Milton Friedman

I don’t like being dogmatic about my investments. Many investors (including many value managers) have taken to buying gold in large quantities in the sure belief that currency debasement by countries around the world will erode the value of paper money. The standard paradigms of monetary theory which are the basis for this belief have been pretty fluid lately (see: St. Louis Fed thoughts on Money Velocity), but the threat of money losing its value certainly remains given the unprecedented rises in money supply. I can’t help but hear Milton Friedman’s “inflation is always and everywhere a monetary phenomenon” in the back of my mind.

Commodities are a bad investment for the long term. Commodities don;t produce anything, so you are just betting that a the supply and demand relationship will change over time and the price will rise. In fact you have to bet that the price will go up fast enough to offset the cost of holding a commodity in storage. Gold is no exception, despite its stellar performance over the last 10+ years (Performance looks difference if you look back to the early 80s).

It was with all this in mind that I made an investment in Barrick Gold (NYSE: ABX) on September of last year for $18.28 per share. The stock is down about 10% since then, having traded in a relatively narrow band all year. It is still well below its previous highs of $50+ (when the gold price was topping new highs).

On the one hand, it is hard to escape the fact that investing in a gold miner is inherently a bet on the price of Gold. What I like about it however, is that by investing in a mining business (vs. investing in the commodity directly), you get the optionality that comes along with backing a dynamic business that will adapt to the circumstances. In the short term, there is not denying the impact of the spot price on the Company, but in the long term, Barrick Gold (like most good business interests) will adapt to the environment in which it operates and adjust its operations accordingly. After all, almost no business has complete insulation from the pricing environment of the good they produce.

If the spot price rises dramatically, the Company might race to develop new assets and increase production (like it did in 2012-13), even if that means a rising cost per ounce mined. Conversely in a less favorable pricing environment (like today), the Company will be more cautious, dial back production and focus on its most cost effective assets. The halted development of the Pascua-Lima mine is a case in point.

I was looking for a good way to illustrate and visualize this, and I came up with the concept of “All-in Sustaining Profits” (or “AISP”) for a given level of gold price realized. I don’t pretend that this little model is predictive of near term results, but I think it is indicative of the long term profit potential of the current stock of mining assets.  The idea is based on the Company’s published All-In Sustaining Costs (“AISC”) for its gold core mining assets, and it simply assumes that in the long run mines that can be operated as AISC below the realized gold price (i.e. “profitable mines”) will operate at production capacity, while those which would not be run profitably will not be run at all.  AISC takes into account sustaining capex, and therefore my estimate of total AISP is roughly corresponding to EBIT.

The table below outlines the key statistics provided by the Company for its key assets for the last 3 years (2014 = midpoint of the Company’s “2014 outlook”) and shows the calculation of AISP based on realized gold prices for the respective years:

Source: Company Filings.
Source: Company Filings.

I think it is worth emphasizing again, that this is a rough and indicative measure. There are lots of issues with it, including: AISC may rise and fall over time, the Company may be able to realize lower AISC at lower production levels (i.e. my “binary” assumption of whether a mine is run or not is poor) and mines that have received heavy investment might have cash costs that are low enough to keep operating them, even if the total AISC might categorize them as unprofitable—just to name a few. Notice that despite my comment above comparing my AISP to EBIT, looking at 2013 and 2012 at the Company’s average realized gold price for those periods it represents 85% of EBIT (2013 EBIT: 4,703m) and 75% of EBIT (2012 EBIT: 6,606m) respectively.

The chart below shows AISP and production levels based on the Company’s 2014 outlook at various levels of the Gold price. If anything, I think it is helpful to note that even at very low price levels, the Company would likely still be able to run profitably in the long run, even if that means being a smaller concern, exploiting a smaller set of assets

"All-In Sustaining Profit" and assumed production at various level of gold price.
“All-In Sustaining Profit” and assumed production at various level of gold price.

Value

In many ways the “value play” in this investment has a lot more to do with the original point regarding currency debasement. If this will prove to be a great investments, then some part of that thesis will be correct. The other face of the argument is ultimately more about downside protection and safeguarding against loss (a very important factor!).

Assuming 10x long term sustainable EBIT multiple (i.e. AISP in my example), The Company would retain its full current value even if Gold prices settled around $1,000 per ounce. Again, this is not to say that if the gold price dropped to $1,000 tomorrow and stayed there the Company’s stock would not go lower, but rather to imply that if that were a long term scenario, the chances of at least breaking even on the investment would be good. If I further assume that AISP should be “grossed up” to EBIT based on it representing 85% of it (again, a very rough assumption), then the gold price level at which the long term value of ABX remains attractive is even lower.

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