If you want to estimate the intrinsic value of a gold mining stock, better known as its "real value," it's important to consider a pair of factors as part of a strategy that excludes the margin added by the stock market.
- The production of gold that the company can put on the market every year.
- An estimate of the future commodity price that reverts on the long-term component of an additive model that is traditionally used to analyze the gold price time series.
Let’s take Barrick Gold Corp. (ABX, Financial) as an example.
Barrick Gold Corp. expects to produce and place on the market a volume of 4.5 million to 5 million ounces of the yellow metal for the entire year of 2018. This means that one share of Barrick Gold Corp represents approximately 0.004 ounces of gold the company will produce in full fiscal 2018. That assumes that the total volume of shares outstanding will stay at 1,166 million.
I want to clarify that the gold price I have estimated is not the price on the London Bullion Market but the price that gold will trend in 2018.
To estimate what value the yellow metal will trend in 2018, I work out an equation of the trend of the gold price. The equation of the trend of the gold price (quarterly data) over the period from April 1, 1968 to October 1, 2017 is: Tt = $504.866 + 5. 846* t.
In this equation, the component 5.846*t is the drift. The chart below illustrates the trend in the gold fixing price 3:00 p.m. (London time) over the last 50 years:
Then I will replace t in the linear equation with the values of the quarters of 2018 (see column E in the below chart) to get the quarterly trend in the price of the commodity and a yearly average.
If you are interested in the exact procedure I followed to compute the equation line of the trend in the gold price, just ask by posting a comment to my article.
So, $1,098.240 is the price that gold will trend per troy ounce on the London Market of the bullion in 2018. This is the value that constantly appreciates over time as worldwide mineral gold deposits run out. This value is more respondent to the need of having an intrinsic value for the yellow metal. The market price contains other components, such as the gold price volatility and the jumps and dips that affect the price of the commodity on the market. Of course, those two, which are called diffusion component and jump/dip component of a 3 factors additive model for gold price time series analysis, are more reflective of market and macro-economic factors than the real value of gold.
Now, if I multiply 0.004 ounces of gold, which represent one share of Barrick Gold Corp, by the estimate of $1,098.240, I obtain a value of $4.4 per share of Barrick Gold Corp.
This is the real value of the gold stock. Of course, as of today it is an unreasonable price. We need to go back 30 years to see Barrick Gold Corp trading at such level.
With this, I hope to provide readers with a demonstration that shows that, as of today, Barrick Gold Corp and most likely any other U.S. publicly-traded gold stock is overvalued by the market. These stocks are being traded at a value, which contains a sizeable mark-up.
This means that these metrics should be applied before making an investment decision on a gold producer. And this is true for the value investor as well.
Just to mention some, these are:
- The EVO, which is calculated by dividing the total ounces of proven and probable gold reserves of the miner by the enterprise value. This value should be compared with the one of the peer companies.
- The share price that lies on the SMA line computed over the last 50, 100, 200 days of trading and compare this to the current market value.
- Seeing how the gold stock is performing compared to its industry. The Van Eck Vectors Gold Miners (ETF) can be employed as a benchmark.
- Compare the current share price with the 52-week range.
- Compare some ratios to the industry medians, such as the price-book (P/B) and the EV-to-Ebitda ratios.
- See how the stock performed over the last 12 months of trading in terms of Ebitda margin at a specific commodity price and compare the ratio to that one of the peers.
- Follow how insiders are moving their investments on their own company and use the average price at which they sold or bought shares as an indicator of the stock’s value.
(Disclosure: I have no positions in any security mentioned in this article.)
