by Daniel Jennings
The success or failure of economic stimulus policies in the U.S. and China could decide the price of gold and the future values of gold mining stocks. Gold values recently took a large fall after the U.S. Federal Reserve announced it was not taking any further action to help the economy. This was the biggest fall in prices since March.
Stimulus measures often help the price of gold because they devalue currencies and increase government debt. This can increase inflation, which makes gold more attractive as a safe haven for money. Unfortunately, the reverse is often true. The refusal of governments or central bankers to bite the stimulus bullet can cause gold prices to fall.
Gold prices fall because a lack of inflation increases the buying power of cash, so there is no incentive to buy gold. Instead, cash investments, such as savings accounts, become a more attractive safe haven. Many investors actually sell gold in such a situation in order to get more cash.
Interestingly enough, gold prices recovered one day after the fall, which indicates that traders might think that some sort of stimulus is imminent. After all, the Fed's recent announcement was accompanied by poor economic data from the U.S., Europe and China.
Barrick in Good Position to Capitalize on Stimulus Failures
The continuation of the debt crisis and the failure of U.S. austerity policies should benefit companies such as Barrick Gold (ABX), which focus on gold production. Barrick fired its CEO, Aaron Regent, who was trying to transform the company into a diversified miner in June. Regent had increased Barrick's exposure to other metals, such as copper, by purchasing Equinox Minerals Limited.
The move was a shaky one that drove down Barrick's stock values because it moved the focus away from gold at a price when gold prices were increasing. Gold can provide a company such as Barrick a hedge against inflation and the volatility of other metals. Unlike giant metals producers, such as Freeport-McMoRan (FCX), BHP Billiton (BHP), and Xstrata (XTA), Barrick is not heavily exposed to either the European or Chinese economies.
Its exposure to the U.S. economy is also limited because its principal product is gold. This allows the company to keep producing cash flow even in times of lower industrial demand. The stock value of Barrick and other gold specialists, such as Goldcorp (GG) and RandGold Resources (GOLD), should continue to rise in the current economic environment.
Stimulus policies in the U.S. and China will affect gold stock prices because they will ultimately determine the demand. Any policy that increases inflation or the threat of inflation will increase the demand for gold and the price. Any policy that aims to keep inflation low could do the same for gold prices. The Federal Reserve's insistence on low inflation and interest rates is such a policy. Its commitment to low inflation could depress gold stocks.
The Chinese stimulus polices, which are designed to make more credit available, could increase the demand for gold in China because they bring a danger of inflation with them. The Chinese government is essentially trying to fuel domestic consumption by increasing its money supply. It is trying to achieve this through the classic U.S. mechanism of lowering borrowing costs for consumers and businesses.
Any frenzy of buying brought on by such a policy should increase gold prices and gold stock values. Barrick would be one of the stocks that Chinese investors would presumably be interested in because it is based in Canada, which is considered a safe and stable nation. Barrick also deals in gold, which Chinese traditionally turn to as a safe haven investment in times of economic uncertainty.
The reason why the new Chinese economic policies could be good for gold stocks is primarily psychological. The new debt-driven economic policies that the Communist Party is trying to implement will increase volatility by moving China towards a financial system that is more like the ones in Europe and the United States. This will increase distrust in the system, which will increase the demand for physical investments such as gold.
It will also drive many wealthier Chinese to start placing funds in foreign stocks in stable countries. Barrick Gold and Gold Corp would look like good investments for such wealthy Chinese. Their values are likely to start going up and continue to rise as the economic changes come online in China.
Another potential problem in China is that there is no guarantee that the country's financial system is capable of absorbing or controlling all that additional lending. Banks and other institutions are likely to get overextended and collapse. If that happens, there will be a huge outflow of capital from China. A lot of that capital would flow into gold and gold stocks.
Stimulus Good and Bad for Barrick
So the stimulus policies in China could be good for Barrick, while the lack of stimulus in the U.S. could hurt its share value. There is no real incentive for Americans to invest in gold or gold stocks right now. There are some incentives for Chinese to make such investments, but only if new policies begin to have an effect.
If these policies are continued on a long-term basis, China will probably see inflation, which will be good for gold prices and gold stocks. The United States will see prices remain flat or even fall, which is actually bad for gold. Only serious gold bugs will hang on to the metal, and there could be a substantial selloff as investors look for bargains in other areas such as real estate.
High gold prices could actually spur such a selloff because Americans would have every incentive to sell gold and use it to pick up bargains in stocks. A situation of falling U.S. prices and rising gold prices could easily result if the economic volatility continues overseas. Chinese stimulus polices and the weak economy that is driving them could be the catalyst for such a situation.
Companies like Barrick Gold would benefit from that situation because they could sell any gold for cash, which would increase revenues and dividends. The large amounts of cash have always been what attracted value investors to gold companies.
Low prices in the U.S. could benefit Barrick in another way, its operating costs for its Nevada Mines, such as Cortez and Bald Mountain. That could increase profits and earnings per share.
Barrick itself could be a bargain right now because of some of the setbacks it has recently suffered. In addition, in its CEO shakeup, the company just lost a round in its court battle for control of the El Morro gold and copper mine in Chile. On June 26, a court in Toronto dismissed Barrick's claim that GoldCorp's bid for a 70% stake in El Morro was invalid. GoldCorp outbid Barrick for the stake Xstrata was offering.
The El Morro case should not have that big of an effect on Barrick because the company's position is fundamentally strong. A failure to get El Morro could help Barrick by leaving it free to focus its attention on its North American gold mining operations.
Barrick Gold would seem to be the best value pick in the gold area right now. It has good fundamentals and a core business with strong growth potential. More importantly, its basic operations are being helped by the current economic policies being pursued in the U.S. and China.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.