Bill:
I have been wondering for a while why ABX is underperforming even when GLD is moving up. Last week Goldman removed it from its "Americas conviction Bu list", but still maintained buy. BMO and Canaccord Adams downgraded ABX recently.

1) Are you removing it from the Cara 100? Now that they are dehedging fast should it be a better buy now?
2)Without knowing the price they hedged, how do we know if it was a good deal or not? (what if they hedged when gold was 690)?

JogyP,

I'm no expert in gold investing, but let me take a stab at your question.

Let's compare a low cost producer like Goldcorp, with a higher cost producer (call it HCP).

1. It costs GG $200 an ounce to produce gold. HCP mines gold for $300/oz.
2. At $600/oz, GG will earn a profit of $400/oz, HCP a profit of $300/oz.
3. Let's say Wall Street expects earnings of $1/sh from GG, and $1/sh from HCP.
4. Then the price of gold rockets to $700/oz.
5. Now GG earns a profit of $500/oz, and HCP earns a profit of $400/oz.
6. So GG's earnings increase by 25% (500/400), but HCP's earnings SOAR by 33% (400/300).
7. Guess whose share price will appreciate more? HCP, the higher cost producer!

For a company that hedges, I would think the bull-market scenario works in reverse.

Would apprecicate any clarifications from other readers.

2nd_Ave

Further thoughts on the above post:

A higher cost producer is also more likely to have mining properites not in production b/c operating costs are too high. As the price of gold spikes, it becomes profitable to open them up. The earnings of HCP may then jump far beyond $1.33/sh. Although counter-intuitive, investing in the shares of a high cost producer will yield a better return in a bull market. Wall Street is only concerned with earnings growth, not with a miner's operating cost (which is probably already factored into the current share price).

2nd_Ave

ALOHA !!

2nd ... In your example I'll buy GG with a 350% profit over the HCP profit of 233%.

Opening a dormant mine is expensive especially in enviro/politico areas. With the added profit GG makes they can go out and buy new properties or mines to add to their future production. Low cost producers also have future production waiting in the pipe.

Hedging kills bottom lines in this environment ... JoyP I believe Barrick began hedging at the $300-350 level. As I recall you have to look at the footnotes in their financials. Barrick is an agent for the US government/Fed per Blanchard vs Barrick lawsuit settlement, so rolling over hedged positions into infinity would not be out of the question. I would not own Barrick they seem to be a Fed clearinghouse for super hedged producers like some of their recent acquisitions such as Placer Dome. What did Barrick do with all Placer Dome's hedged gold? Their attempt to bully Novagold and low ball the shareholders is classic 800lbs gorilla tactics. One would think that by their heavy-handed tactics and impunity they were an agent for the US government ... or something!

Kaimu,

Yes, I agree that Goldcorp would make more money. But I'm assuming that investors have already factored that into the "initial" share price. What Wall Street will be looking at is the % growth in earnings-and for any given increase in the price of gold, the % increase in earnings will be higher for HCP. Hence, a higher % increase in the shares of HCP in a bull market.

But yes, if you are a long-term investor, you go with the company that's actually making more money.

My first post in this great blog,

I humbly thought that this example was related to operating leverage and a consequent influence on beta and sensibility to market volatility. As a link to a relevant paper:

http://ideas.repec.org/p/bos/wpaper/wp2005-002.html

A friend of mine is also presenting his thesis on operating leverage as a stock predictor in Stockholm, Sweden.

However, regarding the case above, the data on composition of fixed vs. variable case is unknown to me. What do the experts here think about that? Any data?

Best wishes to all