Are Gold Mining Stocks Undervalued ?
A gold mine is a hole in the ground with a liar on top - Mark Twain
Gold has shone brightly in recent years, but gold mining stocks have failed to keep up with the price of gold bullion. This chart shows Barrick Gold and Newmont Mining against the gold ETF GLD which tracks the gold price.
There are a number of reasons for this under performance. Firstly, the kind of people who buy bullion are different to those that buy gold stocks; central banks for instance do not buy gold stocks. Secondly, investors still haven't got over the Bre-X scandal even though standards on the reporting of reserves have been greatly improved since that time.
It may also have something to do with the fact that many investors don't fully understand how to value mining stocks.
Valuing a gold mining company is very different to valuing a company such as Coke. P/E ratios, earnings per share, free cash flow and most of the other measures you find on the balance sheet are all largely irrelevant. Instead what really matters are just 2 numbers:
- the amount of gold the company owns.
- The cost of digging it out of the ground and processing it
Barrick Gold, is the world's largest mining company and has known reserves of 138.5 million ounces. The cost of production is $443 an ounce. So with a gold price of $1723.30 an ounce Barricks reserves are worth $1280.3 ($1723.30 - $443) an ounce giving a total value of $177,321,550,000 ($1280.3 times totals reserves). With 982.96 million shares outstanding, each share is worth $180 in gold ($177,321,550,000 / 982.96 million). However the share price is only $49.07 making it something of a bargain. This is of course an over simplification because there are other metals such as copper and silver that the company produces but it illustrates the point.
For Newmont Mining the figures are:
- Known reserves: 87 million ounces
- Value of reserves: $111,386,100,000 ((gold price of $1723.30 an ounce - production costs of $443 an ounce) * reserves)
- Shares outstanding: 490 million
- Value per share: $227
- Share price: $61.01
Some companies are able to extract the gold more cheaply than others. For example Yamana's costs are $200 an ounce.
For Yamana the figures are:
- Known reserves: 19 million ounces
- Value of reserves: $28,942,700,000 ((gold price of $1723.30 an ounce - production costs of $200 an ounce) * reserves)
- Shares outstanding: 733.25 million
- Value per share: $39
- Share price: $17.15
It is clear then that at current prices gold shares are undervalued and if you are bullish on the yellow metal it probably makes more sense to buy gold stocks than bullion.
- Holding shares in gold mines can be a secure way to keep your gold. Keeping bullion or coins in your house is risky. Gold held in a bank could be subject to government confiscation. This might seem unlikely in this day and age but its worth remembering that in 1933, President Roosevelt ordered U.S. citizens to surrender all their gold coins, gold bullion and gold certificates to the Federal Reserve. Shares in gold mines were not included.
- Adjusted for inflation, gold is still below its all time high.
However you should be aware that:
- By historical standards gold is expensive relative to wages and gasoline which are the main production costs.
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