Barrick Gold: If It’s Good for Hedge Fund Chiefs Vinik and Einhorn . . .

Jeffery Vinik likes Barrick Gold (ABX); his hedge fund company, Vinik Asset Management, owned about 2.6 million shares of the mining giant as of the end of 2012. Should you follow the lead of this former Fidelity Magellan fund portfolio manager? Or that of David Einhorn, a fan of gold, who used a dip in the stock price late last year to double his stake in the company, the world’s largest gold mining concern?

ABX Chart

ABX data by YCharts

Unless you’re a believer in deep value plays, or have a hefty supply of Pepto-Bismol tucked away in your bottom drawer, this may be a stock you want to leave to the pros. Not only is the stock price on a distinctly downward trend, as seen in a stock chart, it looks volatile, to boot. That’s an uncomfortable combination. Then there’s the daffy logic behind owning gold, explained with quiet venom by Warren Buffett. And gold mining stocks – including Newmont Mining (NEM), Goldcorp (GG), Kinross Gold (KGC), Gold Fields (GFI) and Novagold (NG) – fall faster than the price of gold itself when gold tumbles.

ABX Chart

ABX data by YCharts

Gold has nosedived 11% in the last four months alone, and now is below $1,600 an ounce, a six-month low. And if technical analysts are to be believed, the fact that the precious metal’s 50-day moving average has fallen below its 200-day moving average means investors should prepare themselves for further and faster-paced price declines.

The impact of lower metals prices is starting to show up in Barrick Gold’s earnings. True, the magnitude of the $4.2 billion charge that turned a potential profit into a net loss of $3.06 billion in the fourth quarter came from the $3.8 billion writedown of the value of a Zambian copper mine, not as a result of the lower prices for gold. Clearly, the 2011 purchase of Equinox Minerals Ltd., owner of the Lumwana Mine, hasn’t gone quite as expected. Copper is suffering from the same toxic blend of higher production costs and lower market prices as Barrick Gold’s gold output.

Last year, Barrick said its cash cost per ounce of gold produced was $945; this year, it sees that climbing north of $1,000 (while it realized an average of $1,688 an ounce for the gold it sold.) That production cost is moving in the wrong direction, given the fact that prices are falling and that the company has said that it doesn’t expect production levels to increase much this year. Not a heartening sign on profit margins.

ABX Cash from Operations Quarterly YoY Growth Chart

ABX Cash from Operations Quarterly YoY Growth data by YCharts

The problem that some analysts fear is that this scenario is going to put an unacceptable degree of downward pressure on the company’s cash flows and its cash position. Barrick has cheerfully acknowledged that it is far more sensitive to a change in the price of gold than are its peers: a change in the metal’s price of $100 per ounce results in a gain (or loss) of 50 cents per share to the company’s earnings, compared to an industry average of 32 cents a share, it told analysts at a Singapore conference last September. This is the downside of the kind of leverage that gold bugs celebrate when gold’s price is rending higher.

Little wonder, then, that Barrick’s CEO told the Wall Street Journal in an interview last week that it is undertaking a comprehensive review of its assets, looking for candidates for divestitures.

But Barrick already has stumbled in its efforts to unload one of the problem areas, African Barrick Gold PLC, to a Chinese buyer last year. That Barrick-controlled business is still on the block, as are non-core areas such as its energy assets. The problem with this scenario? Many, if not all, potential buyers are struggling with the same problems that Barrick confronts: higher production costs and low or declining commodity prices. Jamie Sokalsky, the company’s CEO, told the Wall Street Journal that he wants to sell assets that are “higher-cost, shorter-life, lower-return, low free-cash-flow-generating”; that’s hardly a surprise, but why would he imagine that those, rather than the company’s crown jewels, are assets for which buyers will be interested in paying a price that the company considers to be fair?

There are few reasons to expect a quick recovery in the price of gold. Investor demand for gold has slumped this year as a more upbeat tone has taken over the stock market and cast “risk off” investments like government bonds and gold into the shadows. So far, there’s no catalyst for a reversal of that pattern in sight.

Suzanne McGee, a contributing editor at YCharts, spent nearly 14 years as a reporter at the Wall Street Journal, in Toronto, New York and London. She is also a columnist for The Fiscal Times, and author of "Chasing Goldman Sachs", named one of the best non-fiction books of 2010 by the Washington Post. She can be reached at editor@ycharts.com.

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