By Dave Goodboy
Gold has exploded higher during the past several years. The bullishness has been ignited by massive global fiscal stimulus programs, slowing production growth and aggressive purchasing of the yellow metal by several central banks. It's no wonder gold prices are up nearly 100% during the past five years.
Take a look at the weekly chart:
Although the yellow metal is off its all-time 2011 highs of more than $1,900 per ounce, there is solid technical support in the $1,550 area, as you can see in the chart below. Gold has since bounced from this support, hitting $1,800 per ounce in October prior to falling back and finding support at the 50-week simple moving average at $1,665.
Despite gold's solid performance over the years, gold-mining stocks have lagged. This is unusual, since gold-mining companies make their profit on the spread between what it costs to extract gold and the price of the commodity. Historically, there is a positive correlation between the price of gold and the performance of gold-mining stocks.
But starting in 2008, there has been a disconnect. Rising production costs, political risks in some of the regions where miners operate and simple economic worries have superseded the common-sense correlation. This has resulted in gold-mining stocks underperforming the commodity itself, which in turn has resulted in much of the negative investor sentiment around gold-mining stocks.
And it is within this negativity that I see a great profit opportunity. The key strategy is simple: Buy undervalued gold-mining stocks poised for a reversal of fortune.
In this case, I think one particular gold miner is a diamond in the rough.
Barrick Gold Corp. (NYSE:ABX) is one of the world's largest gold miners, with 27 operating mines in North America, South America, Australia and Africa. The stock has been smacked down from its recent high of $43 a share in mid-September to $34 in November, which is just above its 52-week low. Barrick Gold boasts the lowest price-to-earnings (P/E) ratio of its peers at 10.2, and its 29% earnings growth rate is the highest among the competition.
Hedge Fund Ownership
The fact that hedge fund wizard David Einhorn doubled his position in the stock during the third quarter and held it steadily this quarter despite the price drop, gives me even more confidence in Barrick Gold. The gold miner makes up about 1.3% of Einhorn's U.S. long portfolio (1.9 million shares), indicating a strong bullish bias for the company.
Barrick Gold has ambitious plans to reduce costs while ramping up copper production in the coming years.
New CEO Jamie Sokalsky is pushing for Barrick's mining costs to drop from $575 per ounce to between $500 and $525 per ounce during the next several years. The cost reduction will come from two mines in the Dominican Republic and on the Chile/Argentina border, which have relatively lower operating costs.
Although Barrick has narrowed its gold production forecast to between 7.3 and 7.5 million ounces from earlier projections of 7.8 million, Sokalsky is confident of a production increase during the next several years. If gold and copper prices stay steady, then the lower production costs will result in increased operating cash flow. Interestingly, despite all these tailwinds, the stock has dropped nearly 30% this year.
At the end of October, Barrick's price plunged through the 50- and 200-day simple moving averages, finally finding support at $33 a share. Most recently, shares have bounced above $34. The weekly chart indicates support at $32.
The company plans to release its full-year earnings report on February 15, 2013. Savvy investors will likely be waiting attentively.
Risks to Consider: Commodity-based stocks are inherently risky. The risk comes from several sides, namely the volatile nature of commodity prices. If gold prices unexpectedly plunge, then so will mining stocks. In addition, political and economic risks also loom largely due to the fact that many gold mines are located in politically and economically unstable regions. Always be certain to use stops and position size properly when investing.
Considering the stock's current value and the company's future plans, Barrick Gold is a great buy now. Any price between $32 and $35 would make an ideal entry. If gold prices remain relatively steady and the company meets its cost-reduction goals, then shares could easily rise to $50 within 24 months. My trading strategy with this company would be to enter a position within the $32 to $35 channel with stops at $32.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.