Gold's shimmer is losing its luster. And as gold grows more dull, Barrick Gold (ABX 3.82%) feels more and more pain. Barrick is running into considerable trouble as gold, its primary commodity, falls down from the stratosphere.
In 2012, Barrick, which is the world's largest gold miner, saw its market cap dip below that of much smaller mining company Goldcorp (GG +0.00%). At that time, Barrick's market cap was $35.30 billion while Goldcorp's cap was $35.32 billion. As both companies continue to fall, the gap is widening. Today, Barrick's cap is $18.69 billion compared to Goldcorp's $23.91 billion. Respectively, the reductions represent a 47% and 32% decrease in value.
Meanwhile, the gap in net income is also widening. In 2012, Barrick reported a loss of $0.67 billion, compared to Goldcorp's profit of $1.7 billion. Fastforward to the second quarter of 2013, and things get worse for Barrick. For the second quarter, Barrick posted a massive loss of $8.56 compared to Goldcorp's loss of just $1.93 billion
Now, is Barrick about to rebound? No. Here are three reasons that this stock isn't going to hit the jackpot any time soon.
1. Trouble in Chile
In May, the Chilean government fined Barrick $15.8 million for "serious" environmental violations at the large Pascua-Lama mine. Before handing out the fine, Chilean officials forced Barrick to suspend operations until the environmental issues are resolved. According to Barrick, there was a problem with the mine's water management plan. Today, the mine is still shut down, further delaying an opening originally scheduled for 2014.
Anytime a mine isn't running, we have a problem. But a mine of this size presents an especially big problem. With production of up to 850,000 ounces of gold per year, the Pascua-Lama mine is to count for 11% of Barrick's overall gold production. 11%. The project is huge, and the situation isn't getting better. Barrick says it will submit a new water plan soon, but how soon? Will it pass the environmental board's standards? There's just too much uncertainty surrounding this project. I don't like it.
In addition, as the opening is delayed further, costs are going up. Already the estimated costs rose 34% to $8.5 billion, and more increases are likely. Some have even speculated that Barrick may scrap the project. However, Silver Wheaton Corp (SLW 3.01%) – a mining finance company involved in Pascua-Lama – said in a statement that Silver Wheaton remains confident about the project's future.
I would say confidence is a necessity since Silver Wheaton owns a 25% stake in Pascua-Lama's silver production – an estimated nine million ounces for the first five years. For 2013, Silver Wheaton's estimated silver output is 33.5 million ounces. That means Pascua-Lama accounts for about 5% of Silver Wheaton's production, so you can bet that Barrick isn't the only one worried about the mine.
Still, I agree with Silver Wheaton. I don't think that Barrick will go as far as scrapping the project, but I do think the miner needs to accelerate the process of getting Pascua-Lama up and running again.
2. Costs down under going up
Last month, Barrick announced that it would be making significant cuts in Australia. These cuts include laying off some 50 employees and closing a Greenfields exploration unit in Perth, Australia. 50 people doesn't seem too severe, but the downsizing underscores a bigger problem: rising costs.
According to Barrick's website, the cost of producing one ounce of gold in 2013 will be between $880 and $950 per ounce. The cost is up around 14% from $803 per ounce in 2012. Australia has an abundance of gold and silver reserves, but that doesn't matter if Barrick can't extract them with maximum profitability.
3. Gold stumbles
A mining company is only as valuable as the commodity it provides. Unfortunately for Barrick, gold is no longer climbing. A look at the SPDR Gold Trust ETF (GLD 3.76%) shows that gold fell 25% since October of 2012. Following the recession, gold went steadily upward as investors clung to its stable value and feared inflation. Now, as markets begin to improve, investors are loosening their grasp on the commodity and returning back to income producing assets. As a result, the price of gold is slipping.
Take a look at how closely Barrick's stock price is tied to the value of gold. Using the past 20 trading days as the input, the current correlation is .93.
However, note the operating leverage inherent in the mining sector. Every dip the Gold ETF took, Barrick took more severely.
Final Thoughts
When a stock is trading as low as Barrick's, it's tempting to snap it up and hope for a turnaround. I say wait. Barrick may turn around eventually, but first the firm needs to regroup and do everything in its power to get Pascua-Lama back on track. Barrick may not be able to control the price of gold, but the miner should be able to keep its own operations running smoothly. Moreover, if Barrick does end up scrapping the project, the stock could descend even further.
I'm not saying Barrick is finished, but there are too many uncertainties to justify a long position. The miner could turnaround at some point, but in the meantime, stay bearish on Barrick.
Just as gold lost its shimmer, Barrick is ceasing to shine.
