Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

Current and Future Valuations of Gold Mining Stocks

|Includes: Barrick Gold Corporation (ABX), GG, HMY, KGC, NEM
Industry Overview
The global Gold Mining Industry is growing at a tremendous rate yearly with around 3,343 companies that were involved in the business of mining gold world over in the year 2010. Some of the major companies in this field are Barrick Gold Corporation (NYSE:ABX), Goldcorp Incorporated (NYSE:GG) and Newmont Mining Corporation (NYSE:NEM). Gold prices have been shooting up tremendously and are currently hovering around the $1225 mark. The markets have been offering differing opinions regarding the rise in price of gold, some believe that it is just a bubble waiting to burst while others are of the opinion that prices have not yet peaked and are likely to cross the $2000 mark by the end of the year.
 
Principles of Investing in Gold Mining Companies
However, no matter where the gold prices go, by following certain fundamental principles before investing in gold mining stocks, one can be assured of good returns. The most important things to look at before buying the stocks of a mining company are its potential reserves and its cost per ounce. Companies with high mining costs are riskier since it gives them a lower profit margin and thus a low gold price will make them unprofitable. Thus, it is always safer to invest in companies who have low cost per ounce. Apart from the costs involved, it is also necessary to analyse the future sustainability of the mining operations by having a look at the current reserves of the company. The value per ounce of reserve is another interesting figure that stands for the amount of money that the investor is paying for the gold in the ground, and is obtained by dividing the market capitalisation by the amount of reserves. The lower is this figure the better is it for the investor.
Another important factor to consider while investing is the leverage a company has to the price of gold. For example, consider two companies A & B, one with a low cost per ounce at $100/oz and the latter with a high cost per ounce at $200/oz.  The table below shows the hypothetical profits for these two companies at various prices of gold. 
 
Price of Gold
Company A
Company B
$150 / oz
$50 / oz
( 50) / oz
$ 200 / oz
$100 / oz
Break even Point
$ $300 /oz
$200 /oz
$100 /oz
$ 400 /oz
$300 / oz
$200 / oz
 
As seen from the above table, at the price of $400 / oz, the profit of Company B doubles, a fact which will surely be reflected in its market price. Thus, high cost companies are highly leveraged to gold prices and thereby have a greater expansion in their profit margins in turn giving higher returns. Hence, if the gold prices are expected to soar, it may be beneficial to invest in such companies so as to gain from their leverage.
 
Current Valuations
Barrick Gold Corporation (ABX), with a yearly gold production of 7.42 million oz, has the greatest market capitalisation, of $40.64 billion. This makes it the largest gold production company in the world. It has its headquarters in Toronto, and gold mines in North America, South America, Australia and Africa. It has current reserves of 139.8 million oz and its cost per ounce is $ 466. Barrick has benefited greatly from its recent de-hedging decision. Traditionally, Gold mining companies have always indulged in hedging so as to protect themselves from price fluctuations. However, keeping with the trend of the modern day “gold rush” many mining companies now prefer to de-hedge their risks and reap the benefits of the price rise.
The company with the second largest market capitalisation, of $ 30.8 billion, is Goldcorp Incorporated (GG). They have a yearly gold production of 2.42 million oz, which is nearly one third that of Barrick. It is also the company with the lowest cost per ounce at $ 295. However they have relatively low gold reserves of 48.75 million oz due to which their valuation per oz of reserve is very high, at $632.
The best valuation per oz of reserve is of Harmony Gold Mining (NYSE:HMY) at $84 with a market capitalisation of $ 4.06 billion. This company appears to be giving its shareholders the best price for its reserves. It currently has reserves of 48.2 million oz, and a yearly gold production of 1.4 million oz. However, these figures can be deceptive as the company has relatively high costs per ounce at $ 583, which could significantly affect its sales and profits. Depending solely on valuation figures can, thus, be misleading and so it is very necessary to have a holistic picture of the organisation.
Taking all factors into consideration, two stocks emerge winners in the current scenario. They are Kinross Gold Corporation (NYSE:KGC) and Lihir Gold Limited. This is because they have a good valuation per ounce as well as below average costs per ounce. Kinross Gold Corporation has a yearly gold production of 2.24 million oz and has current gold reserves of 51 million oz. It has a valuation of $231 per ounce and a cost per ounce of $437. Lihir Gold Limited has a yearly gold production of 1.1 million oz and has current gold reserves of 30 million oz. It has a valuation per oz of $273 and a cost per oz of $397.
 
Future Potential
The table below shows the market capitalization of each company along with the future profits that it is capable of making at the current price. On comparing these two figures we can determine which stocks are currently undervalued and thus, have the potential to perform better in the future.
 
Company Name
Market Cap $B
Profit from remaining reserves ($bn)
Ratio of Future profit to Market Cap
Barrick Gold Corporation
40.64
102.61
2.52
Goldcorp Incorporated
30.80
44.12
1.43
Newmont Mining Corporation
26.20
66.10
2.52
Anglogold Ashanti Limited Ads
15.18
48.98
3.23
Eldorado Gold Corporation
8.97
11.79
1.31
Kinross Gold Corporation
11.76
38.91
3.31
Gold Fields Limited Adr
9.29
55.00
5.92
Yamana Gold Incorporated
7.73
13.60
1.76
Lihir Gold Limited
8.19
24.09
2.94
Randgold Resources Ads
7.70
6.54
0.85
Agnico-Eagle Mines Limited
8.98
16.34
1.82
Silver Wheaton Corporation
6.11
0.26
0.04
Iamgoldcorp
6.05
10.72
1.77
Harmony Gold Mining Adr
4.06
29.74
7.33
 
From the above table it is clear that some stocks, like Harmony Gold Mining and Gold Field Limited, will definitely perform well in future as currently they are undervalued by the market. Most companies have a ratio of future profits to market cap, of around 2-3, which is the industry average. However, the ratios of both Harmony Gold mining and Gold Fields Adr, are way above the average, signalling that these stocks can provide good returns in the long term.
 
What happens if Gold reaches $2000 / oz
As mentioned before, different companies have a different leverage to gold prices causing them to give different returns when the price of gold increases. The table below shows the cost per ounce for each company, along with the expected increase in profits per oz if gold touches $2000 / oz.
 
Company Name
Cost per Ounce
Profit per oz @ $1200
Profit per oz @ $2000
Percentage increase
Barrick Gold Corporation
466.00
734.00
1534.00
108.99
Goldcorp Incorporated
295.00
905.00
1705.00
88.40
Newmont Mining Corporation
480.00
720.00
1520.00
111.11
Anglogold Ashanti Limited Ads
514.00
686.00
1486.00
116.62
Eldorado Gold Corporation
419.50
780.50
1580.50
102.50
Kinross Gold Corporation
437.00
763.00
1563.00
104.85
Gold Fields Limited Adr
521.00
679.00
1479.00
117.82
Yamana Gold Incorporated
427.00
773.00
1573.00
103.49
Lihir Gold Limited
397.00
803.00
1603.00
99.63
Randgold Resources Ads
361.00
839.00
1639.00
95.35
Agnico-Eagle Mines Limited
312.00
888.00
1688.00
90.09
Iamgoldcorp
461.00
739.00
1539.00
108.25
Harmony Gold Mining Adr
583.00
617.00
1417.00
129.66
 
It is apparent from the above data that a low cost company, such as Gold Corp Inc, will not have too much expansion in profits and thus, will not give high returns. On the other hand, a company with high costs per ounce, such as Harmony Gold Mining, will have tremendous increase in profit. The profits of Harmony Gold mining are forecasted to increase by nearly 130% if gold touches $2000 / oz. Thus, if an investor wants to get high returns, it is sometimes beneficial to invest in the so called risky companies, with high costs per ounce, as they are the ones which give greater returns.
 
Conclusion
With the financial markets showing an up-trend, investing in gold mining companies is a great way to beat inflation and obtain great returns. Historically, gold has always been the ultimate investment and now gold mining stocks provide almost as much stability. Investing in such stocks, albeit after a thorough research, can be rewarding for investors irrespective of whether gold prices go up or down.