Barrick Gold (ABX) is the dean of the industry while IamGold (IAG) is a mid-tier producer. SA author Hebba Investments has estimated that each has an all-in cost of producing gold of about $1,300 an ounce. Barrick produces about 7 million ounces a year and has 1 billion shares outstanding. IAMGOLD produces about 950,000 ounces of gold a year and has about 370 million shares outstanding.
Shares of both Barrick and IAMGOLD have suffered with declining gold prices. Barrick is down more than 50% in the past year.
IAMGOLD has dropped even more, falling over 70%.
Every $100 change in the price of gold affects Barrick by $700 million in revenue or about $0.70 per share. Every $100 change in the price of gold affects IAMGOLD by about $95 million or $0.25 per share.
With Barrick shares at $18.20 and IAMGOLD shares at $4.60, shares of IAMGOLD should rise faster than those of Barrick if gold prices rise. Valuing both companies at 10 times operating earnings for example, IAMGOLD shares should increase $2.50 per share or more than 50% with a $100 rise in gold, while Barrick shares should rise about $7.00 per share or about 38% for the same gold price movement. I am not suggesting that 10 times operating earnings is the right valuation method, just using it to show the differing leverage to gold prices.
On the downside, the movements are more interesting. Barrick will lose $700 million for every $100 downward price movement in gold. Barrick ended 2012 with net debt approaching $12 billion. Barrick has a real balance sheet problem if gold prices fall sharply and for a sustained period.
IamGold will lose $95 million for every $100 downward price movement in gold. But IamGold has cash and gold inventory about equal to its debt and can weather a downturn for longer than Barrick.
A pair trade makes sense. Investors who are long IAMGOLD and short Barrick Gold may find the trade profitable. While both companies currently pay dividends, the IAMGOLD dividend rate is at this point higher than the Barrick rate, so the short is self financing to the extent the dividends received from IAMGOLD exceed those payable on the Barrick short. For reference, IAMGOLD yields about 5% while Barrick's dividend pays about 1.1%.
The pair trade is pretty well matched at 4 shares of IAMGOLD long for every share of Barrick short.
I am long IAMGOLD. I will short Barrick in the near future to set up the pair trade.
Additional disclosure: I am long IAMGOLD and will establish a short position in Barrick Gold in the near future to set up the pair trade.