Barrick Gold — 3 Pros, 3 Cons

tdp2664
InvestorPlace
As gold continues to rack up gains, cash flows are bulging for the top miners.  Of course, investors would like to get higher dividends but there will probably be resistance to this.  After all, CEOs like to build empires.  In other words, it looks like we may see a rush of mergers.  This week Barrick Gold (NYSE: ABX ) made a $7.3 billion bid for Equinox Minerals, which is a top copper producer.  This easily trumped Minmetals Resources' $6.5 billion offer for the company.  Interestingly enough, a couple weeks ago Equinox made a hostile takeover bid for Lundin, which is trying to merge with Inmet (but the offer has been dropped).  Got it?  Well, the deals are likely to get more complicated.  But will they be successful?  After all, mergers can be tough to pull off – especially global ones.  For some insight on this, let's take a look at the pros and cons for Barrick. Pros A leader.   Simply put, Barrick is the world's largest gold producer, with 25 mines across five continents.  Last year, the company produced 7.8 million ounces of gold.  What's more, Barrick has 140 million ounces of proven and probable reserves of the precious metal.  The company also has 1.1 billion ounces of silver and 6.5 billion pounds of copper reserves.  Strong financials.   In the gold industry, Barrick is the only one with an A-rated balance sheet.  Because of this, the company has access to low-cost financing, which is critical for mine development and mergers. In 2010, Barrick generated about $4.8 billion in adjusted operating cash flows. The chart.   On news of the deal for Equinox, the shares of Barrick fell by nearly 7%.  Yet it could be a good entry point for investors.  According to Investorplace.com's chief technical analyst, Sam Collins , the stock price is at the 50-day moving average – which is a good support level. Cons Peak gold.   It's getting extremely difficult to find new sources of gold.  In fact, some believe that we are reaching the limits of production.  In other words, even with strong prices, this may not be much help for miners that need to replenish their reserves. Valuation.   There's little doubt that Equinox has solid assets.  Its Lumwana mine, which is based in Zambia, produced 323 million pounds of copper last year.  More importantly, it has a low cost-structure. But the valuation is steep, coming to about 13 times pretax earnings.  Keep in mind that Minmetals pulled its bid because it thought the valuation was higher than its "most optimistic assessment." Costs. Exploration and mining costs continue to escalate. For example, there is heavy usage of energy as well chemicals, steel and concrete.  Miners also must deal with rising labor costs.  And, there are problems with renegotiations of contracts with governments, which are looking to extract more royalties.  Verdict Barrick's move to diversity into copper is smart.  China should remain a huge driver of demand (it already accounts for 40% of the world's supply).  Besides, it will take a few years for any meaningful new copper production to hit the global markets. Also, Barrick's valuation is more attractive now, in light of the recent selloff.  Taking this into account, the pros outweigh the cons on the stock. Tom Taulli's latest book is " All About Short Selling " and his Twitter account is @ttaulli .  He does not own a position in any of the stocks named here.