It’s hard not to feel for the owners of Goldcorp (NYSE:GG) stock. GG stock has been one of the worst-performing stocks this decade, dropping from its 2011 highs of $55 to below $10 in October.
At those lows, GG’s management continued to talk up the company’s turnaround plan. then promptly sold the company to Newmont Mining (NYSE:NEM). The all-stock deal offered only a modest premium for the owners of Goldcorp stock, which promptly plunged as NEM ‘s shares sold off following the announcement of the deal.
GG stock has rallied since then. But although it’s above $11, GG stock still trades at a massive discount to its former valuation. With Barrick Gold (NYSE:GOLD) apparently backing off its plans to bid for Newmont, the spread assigned Goldcorp stock has narrowed as well. Goldcorp investors will receive 0.328 shares of NEM stock for each Goldcorp share. That currently values GG stock at about $11.75, just a 2.5% premium (or deal spread) to the current price of $11.47.
In other words, what GG stock right now provides is ownership of Newmont Mining stock, at a small discount. It’s difficult to see why that is an attractive proposition.
The First Big Problem With Gold Stocks
The problem with gold stocks remains relatively simple. Gold stocks should provide leverage to the price of gold, meaning they outperform when gold goes up, and underperform when gold goes down.
A simple example is instructive. If gold is at $1,000 an ounce, and a company’s all-in costs are $800, the company’s pre-tax profit should be $200 an ounce. Cut the price of gold 20%, to $800, and its profits drop 100% to basically zero. The company’s stock likely falls substantially in this scenario, certainly more than the 20% drop in the value of the underlying commodity.
Raise gold prices 20%, however, to $1200, and profits now double. And the stock should rise much more than 20% (even if the stock won’t necessarily double, as investors may see some risk that gold prices will pull back). In short, and in theory, the move of underlying gold prices should be magnified by gold stocks.
In practice, though, there are two real problems with this theory. The most notable problem is that major gold miners have failed spectacularly to give shareholders that leverage. Barrick has been the most notable disaster, as I wrote last year, but other majors have performed equally poorly.
Over the past decade, gold has gained about 35% (in U.S. dollars). During that time, GG stock has lost 66% of its value. Barrick stock is down 58%. Newmont has been the best of the majors,and it has declined 20%. With dividends, NEM shareholders probably have broken even.
All of these stocks should be rising faster than gold prices, yet they haven’t. Whether the prolem is excessive executive compensation, geopolitical problems, sheer execution, or some combination of them major miners have failed to provide positive returns.
The Second Big Problem
That history leads to a simple question: if an investor is bullish on gold, why would she buy gold miner stocks in general and shares of the major miners in particular? Smaller miners have shown some ability to provide returns, with Kirkland Lake Gold (NYSE:KL) perhaps the best example of late. The diversified, large, majors, however, have made money for their employees , executives,and lawyers, but not for their shareholders.
And if those shareholders see gold moving higher, there are ways to make that bet without the messy aspects of actual mining. ETNs like the VelocityShares 3x Long Gold ETN (NASDAQ:UGLD) or the DB Gold Double Long ETN (NYSEARCA:DGP) offer leveraged exposure. Options trades (though only suitable for advanced investors who understand the trades) similarly can provide weighted upside to gold prices.
To be sure, those strategies entail risk – but the performance of miners over time shows there’s plenty of risk in those trades as well. NEM stock, for instance, sits below 1990 levels. And if gold prices tumble, mining stocks are going to do the same.
Why GG or NEM?
So if an investor is going to buy GG stock – which essentially implies NEM stock – she has to believe that something is going to change. Either miners will become more efficient, Newmont will outperform, or the Goldcorp deal is a good one.
That’s a tough case to make at this point. Miners are trying to focus more on profitability and cash flow, instead of production. That hasn’t done much for share prices of late, however. Recently, Newmont has done better than its major mining peers, but it’s hardly done well.
As far the Goldcorp deal, it’s important to ask one simple question: why was the deal made? If Goldcorp’s assets are so valuable, why is Goldcorp’s management selling them at a modest premium to GG stock when Goldcorp stock is at a 15-year low? The owners of GG stock aren’t even getting any cash in the deal.
Some investors have pointed to the payout being received by Goldcorp CEO David Garofalo and Chairman Ian Telfer. But Garofalo, in particular, has nearly 900,000 shares, restricted stock units, and rights – enough to suggest he would participate in any rally of GG stock on a Goldcorp turnaround. It’s a bit too conspiratorial to suggest that Goldcorp’s board would allow the owners of GG stock to be fleeced simply for golden parachutes.
Rather, the issue seems to be that GG itself doesn’t see its assets as worth much more than $12 per share of Goldcorp stock. So what is Newmont getting in return for giving roughly one-quarter of its equity to the owners of GG stock?
Synergies between GG and Newmont are estimated to be as much as $100 million a year; in the context of a $30 billion market cap for the combined company, that’s a drop in the bucket.
Owning GG stock means owning NEM stock. Owning NEM stock certainly seems like more of the same. It’s hard to see how that’s a good deal, even at a modest discount.
As of this writing, Vince Martin has no positions in any securities mentioned.