Barrick Gold Corporation Still Has More Convincing to Do

Barrick Gold still needs to put out a stronger case as gold rally may be short-lived.

Mar 7, 2014 at 10:48AM

Barrick Gold Corporation (NYSE:ABX) has gained around 11% year to date. This has primarily been because of the higher gold prices this year. Investors feel that 2014's high gold price environment will lift the gold miner higher, which despite showing recent improvements, is still trading at a severe discount when stacked against its 2011, 2012, and a smaller part of 2013's share price levels.

Currently trading at $1,330 per ounce (as of this writing), the price of gold has gained 11.5% year to date. Higher prices have been fuelled by two predominant factors.

First, there is the demand from China. The Asian Tiger seeks to reduce its reliance on the U.S. dollar as a reserve currency and, as such, is building up huge reserves of gold to usher in a new era of a gold standard. In addition, Chinese refiners took advantage of low prices in 2013 and bought large volumes at low prices in order to make bumper profits after refining. This demand has spilled over into 2014 as the current prices, despite being relatively higher than 2013, have had minimal impact on the Chinese demand curve. Brink's Company (NYSE:BCO), the largest provider of precious metals logistics and storage, will add space in Hong Kong and Mainland China, according to Guy Bullen, the firm's senior vice president for the Asia-Pacific region, as quoted on Bloomberg. Brink's increased interest in China, as well as its imminent capital outlay on more storage capacity, suggests that Chinese demand will hold on for the foreseeable future, sustaining the current prices.

Second, gold is regaining its appeal as a safe haven investment. The turmoil in emerging markets following the Fed's January bond buying taper acted as a reminder that, although gains have been made in global economic stability, the markets are still relatively vulnerable. In addition, the crisis in Ukraine has put equities in a tight spot, as signaled by the teetering movements in stock indices over the past week, including a notable sell-off on Monday. All these factors strengthen the case for continued gains in the price of gold.

Investors feel as if a continued increase in gold prices will allow Barrick Gold to squeeze maximum benefits out of its current restructuring plan. The miner is offloading non-core assets and has so far announced divestments worth an estimated $1 billion. In addition, it has slashed its capital and cost budget by around $2 billion. Although reducing investments isn't exactly a good sign for the long run, this move is temporary and is part of the push to improve liquidity and near-term cash flow. This way, Barrick Gold will be able to allocate capital to the cash cow segments of its business, allowing it to capitalize on the recent rally in gold prices while using the least amount of capital possible.

Will this strategy improve Barrick Gold's margins and sustain the gains it has made this year?

Downside risks still high
Predictions still indicate that gold prices will drop for 2014. Goldman Sachs, for instance, forecast a 14% slip in gold prices for 2014. This will translate into an year-end price of around $1,050 per ounce, significantly lower than the current price.

This lower forecast is informed by simple economics. As the Fed continues to unwind its economic support and buys fewer bonds, interest rates will rise, presenting an incentive (yield) that gold does not offer. Thereby, the logic is that investors will dump gold for higher-yield debt securities.

Although gold prices seem to have defied these predictions, the effects of the Fed's policy have longer time horizons than the prevailing drivers of gold's current rally. Chinese demand in the refinery section could top off or drop if prices go too high. Similarly, the crisis in Ukraine as well as the volatility in emerging markets could easily be reversed by swift peace agreements and stronger economic policy in individual emerging economies, respectively.

Foolish bottom line
It is highly likely that the impact of the Fed's decision will hold out for longer, limiting gold's upside in the mid-term. If gold's current rally is halted, how will the situation play out for Barrick Gold? Let's assume gold prices for 2014 drop 14% as per Goldman Sachs' earlier prediction and settle at $1,050 per ounce at the end of the year. In such a scenario, Barrick Gold's turnaround will slow, but its prospects won't entirely be put out. In 2013, it had all in sustaining costs (AISC) of $915 per ounce produced. Using this as a benchmark, Barrick Gold would still be able to operate at a price of $1,050 per ounce, albeit with a very slim margin of safety -- one misstep and it's game over.

This doesn't spell well for a company that had to raise $3 billion in equity in November in order to stay afloat. The gold miner still has to put in more work in its restructuring process in order to restore full investor confidence and regain its lost luster.

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