This could be the year that gold prices bounce higher again, and investors who want to profit from that possibility should consider buying shares of gold-mining companies. These stocks are highly correlated with the price of the yellow metal.
Gold is seen as a safe haven in times of market volatility and uncertainty, and right now is one of those times. Stocks have had their worst start to a year ever. Investors are worrying about an economic slowdown in China, an oversupply of oil, and the trajectory of the dollar. There's also uncertainty about the Federal Reserve's rate decisions. All these factors could depress equities this year.
It's also worth noting a recent Citigroup report on commodities. The bank's analysts cut most of their commodities forecasts once again, based on fears of an overall slowdown in global growth, but they raised their forecast for gold. They now expect Brent crude to average $40 a barrel this year rather than their previous forecast for $51, and they've slashed their forecast for nickel prices. Citigroup raised its target for an ounce of gold by 7.5%, to $1,070 an ounce.
The gold mining environment over the last couple years has seen operating costs increase while metals prices continued to fall. This has resulted in a drying up of new mining projects and cutbacks in spending on mine exploration. But as operating mines level off or slow down production, and fewer and fewer new mining projects come to life, the gold supply will taper off. This will give gold a boost as demand overtakes supply. What's more, investors seeking a safe haven investment during a volatile and uncertain market environment will add to the demand for gold.
Once investors have decided in general to buy stocks in gold mining companies, they may wonder how to pick the best ones. They should target gold miners with relatively low all-in sustainable costs and capital expenditures. Large miners have significantly cut costs and freed up cash similar to Barrick Gold. This puts major miners in a strong position to bypass exploration costs and focus on growth through M&A of proven mines.ABX data by YCharts
Barrick Gold (ABX) is the largest gold mining company in the world. The company posted a net loss on an adjusted basis in its last two quarterly reports, but analysts expect it to log an adjusted profit for 2015 and again for 2016. Drastic and effective cost cutting should aid it in its path back to profitability. What's more, even if the prices of Barrick's stock doubled, it would still seem modestly valued compared with similar miners. The stock is currently trading with a forward price-to-earnings ratio of 18.9, whereas competitors trade at an average forward P/E of 57.
Barrick's share price plummeted from $55 in 2011 to as low as $5.91 in 2015. But strategic moves by management have the company well positioned to bounce back and deal with low metals prices. The company sold about $3.2 billion worth of assets to free up cash last year. It also retired $1.25 billion of debt below its par value. This greatly boosted Barrick's cash position and cleaned up its balance sheet. If gold prices head higher in 2016, expect Barrick Gold's earnings to reflect its cost reductions and increased cash flow in a big way. Also, look for a dividend hike after the company slashed its dividend last year.