Gold is the universal safe haven in tough economic times. In the past, when the price of gold was used as the underlying commodity to value paper currency, an increase in the price of gold was a precursor to inflation. Today, the price of gold is a reflection of the fear in the global economy and the barometer by which we measure its present and future health. Base metals and components for finished metals follow the price of gold. However, the price of base metals is more based in practical application such as supply and demand for the metals used in various industries and applications.
Today I will look at Freeport-McMoRan (FCX) and Barrick Gold (ABX). Freeport and Barrick are among the 10 largest mining companies in the world, in the company of Anglo American (AAUKY. PK), BHP Billiton (BHP) and Newmont Mining (NEM). Freeport is the world's largest producer of molybdenum and the world's lowest cost producer of copper. Barrick produces 33% of the world's gold as well as producing copper. Barrick is the lowest cost producer of gold among the top ten
Both companies produce metals that are reliant on economic health - or lack thereof, and in the case of the base metals, growth. Despite the prolonged recovery process in the U.S., the slowdown of growth in emerging market, the eurozone crisis and the high price of gold neither company's stock has been able to achieve a share price that is reflective of the underlying value of the commodities produced. Let's look at why. For reference, at the time of writing, copper spot is around $3.72 per pound and gold is around $1,640 per ounce.
Freeport-McMoRan trades around $37, has a year high of $56.78 and year low of $28.85. Its market cap is $32.5 billion has a price earning multiple 0.27 and earnings per share of $4.01. The dividend yield is 3.3%. Freeport has total of cash of $4.5 billion and total debt of $3.5 billion. The book value per share is $17.
First quarter 2012 results have net income at $764 million and $0.80 per share which included losses of $0.16 per share in the extinguishing of debt. These figures compare with $1.5 billion in net income and $1.57 per share in the first quarter of 2011. Operating cash flow for the first quarter 2012 was $801 million down from $2.4 billion in the first quarter of 2011. Cash flow from operations is forecast to be $4.2 billion for the full year 2012. Capital expenditures in the first quarter 2012 were $707 million compared with $505 million for the same period in 2011. The company expects capital expenditures to be $4.3 billion in the year 2012. The common stock dividend was increased to $1.25 per share in February 2012.
During the quarter, the company's sales from mines were 827 million pounds of copper, 288 thousand ounces of gold and 21 million pounds of molybdenum. This compares to 926 million pounds of copper, 480 thousand ounces of gold and 20 million pounds of molybdenum for the same period in 2011.
The company expects to sell 3.7 million pounds of copper 1.1 million ounces of gold and 81 million pounds of molybdenum in the full year 2012. Copper cost $1.26 per pound in the quarter compared to $0.79 per pound for the same period in the previous year. The company expects to average $1.43 per pound for copper in 2012.
During the first quarter, work interruptions at operations in Indonesia caused a reduction in the production of 80 million pounds of copper and 125 thousand ounces of gold. Safety and productivity issues at the Indonesia operations are expected to be rectified in the second quarter of 2012. The gold, copper and molybdenum production forecasts are dependent on the resumption of normal operations at another of the company's Grasberg property in Indonesia. The company has expansion plans for two facilities in South America to provide increased output capacity for molybdenum and copper. The North American copper output increased in the first quarter of 2012 over the same period in 2011 as a result of increased production at its facilities in that region.
Barrick trades around $40, has a yearly range of $55.95 and $34.86, a market cap of $39.71 billion a price earnings multiple of 8.86. Earnings per share are $4.48. The dividend yield is 1.50%. The company has total cash of $2.7 billion and debt of $13.37 billion. The book value per share is $23.35.
Barrick will announce its first quarter 2012 results on May 2, 2012. Its fourth quarter and full year 2011 results reported $959 or $0.96 in net earnings per share in the fourth quarter of last year compared with $961 or $0.97 per share in the fourth quarter of 2010. Full year net earnings showed an increase of 33% to $4.67 billion from $3.52 billion in 2010. These results reflected the company's ability to provide strong gold price leveraging. The company's gold production costs in the fourth quarter were $505 per ounce as a result of strong performance from its properties in North America. The company forecasts that its cost of gold production will be $520 to $560 per ounce in 2012. Barrick is one of the lower cost producers. The company also anticipates that copper production will be 550 - 600 million pounds with costs of $1.90 to $2.20 per pound in 2012. During 2011 the company doubled its copper proven and probable reserves from production in the Americas and in Africa. The company increased its quarterly dividend by 25% to $0.15 per share in 2011.
Barrick's 2012 budget for exploration is $450 to $490 million. The funds will be expended on adding properties which will produce in the near-term, conversion of production capabilities at existing mines and some earlier stage exploration in markets where it is already producing and in emerging markets. 45% of these funds will be expended in North America, 20% in the Australia Pacific business unit, 20% in Africa on its copper property, 10% in South America, with the remaining 5% being spent on African Barrick Gold.
Barrick's focus is targeting growth in production of gold. Its Dominican Republic operations will see construction of an optimized power solution to utilize lower cost natural gas. The company has invested in increasing gold production at is properties in South America. Investment in its Saudi property's copper production will see a production increase in the second half of 2012. It is investing in feasibility projects in the Americas with an emphasis on gold properties.
Barrick's overall cost of production for one ounce of gold in 2011 was $460. The 2012 production cost is expected to be in the range of $520 to $560. Taking into account industry wide costs and adjustments, Barrick's overall cost of production is around $640 per ounce. Its competitors are looking at an average of $1,200 per ounce to produce. This price indicates that the price per ounce of the metal has to remain above $1,650 per ounce in order for gold producers to remain viable. The current price of the metal is not indicative of being able to sustain significant present production volume. Barrick's production costs are expected to rise in the near term. Barrick is able to reduce the cost of production by streamlining or cutting production at any of its operations.
The World Bank forecast for 2012 indicates that metals demand has reached pre-recession levels but supply constraints are viewed as a problem and could result in higher metals prices. The forecast goes on to say that production costs of all metals with the exception of aluminum are expected to rise as a result of higher power, water and labour costs. Declining ore grades and environmental factors will also play into the cost increase. Copper prices have remained above production costs because of supply constraints related to slow ramp of production and problems with ore grades, labour action and adverse weather at mine sites. Most of these difficulties have occurred in Chile, which supplies 35% of the world's mined copper. Growth in capacity at projects in Mongolia will cause a decline in copper prices as demand from countries such as India and China decreases and new capacity enters the market.
European news of the economy and its possible reduced demand for raw materials saw a broad market decline on April 23. As countries in the EU struggle with massive debt reconciliation problems, a slowdown in the Euro zone economy is predicted for the remainder of 2012. The manufacturing sector in China was up 1.2% in April to 49.1% from March. Any reading below 50 is an indicator of contraction of production in the manufacturing sector. China is presently the world's largest importer of raw materials, copper and other base metals.
True story: I once went to a dog and pony show for an exploration company that was using divining rods - as in the forked branches used to locate water - to source gold deposits. It was the early 1990's, but that does not even explain why anyone would believe this. It sounded ridiculous. I certainly thought that it was, but there were plenty of people who invested in that company. I don't think they found any gold.
Just how far we are willing to suspend disbelief in order to have access to metals and minerals has been written about recently. The thought of fully robotic exploration and mining in outer space is usually reserved for science fiction. There are arguments to be made for seeing that asteroid and planet mining is viable in the future. Will the demand ever warrant looking to outer space for supply? With backers and advisors who are collectively founders and executives at Google, an astronaut, a Harvard and MIT educated doctor and astrophysicist and a film-maker, it does appear to have some credibility. However, the estimated cost of $1 billion to produce a couple of ounces of space gold hardly seems prudent. Compared to mining asteroids or other planets, earthbound resource exploration and production seems cheap by comparison.
Demand for utility metals such as copper and molybdenum is perceived as the bread and butter side of mine production. These metals have day to day applications which make them boring and plain, compared to the allure and status of gold as a metal. With the bread and butter come the day to day challenges of trying to produce and deliver at low cost and to gauge demand so that supply meets it in a cost effective manner. All indications are that there will be a decrease in demand for copper and molybdenum. The production activities of both of these companies indicate that there will be a decrease in net earnings as a result of decreased per pound price of copper. Also coming into play are the rising labour costs and environmental concerns. No mining company is impervious to these factors. Both Freeport and Barrick have disclosed that these particular issues will impact earnings in 2012.
Expanding production of base metals in stagnant economies and slowing growth in emerging economies does not appear to make sense. The actions of Barrick and Freeport indicate there is not much worry that production costs and increased supply will outweigh any decrease in demand. It appears that each is betting on a sustained per ounce price of gold to offset any decreases in the copper markets. Each is playing a delicate balancing game. Shareholder's have to decide what is the better bet, the company with the largest reserves and production of a precious metal, or the company that can feed the utilitarian demand for base metals.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.