Why I Bought Barrick Gold Today

Barrick Gold (NYSE: ABX) has been a positively disastrous stock so far this year. I had to buy some this morning, because it has become ridiculously cheap.

Here's why the numbers on Barrick are compelling. It booked $6.5 billion in operating profit and $5 billion in operating cashflow last year. It's trading at a market capitalization of $36 billion, or about six times cashflow. That is cheap. The average earnings estimate for this year is $4.84 per share. That means it's trading at a forward P/E ratio of about 7 -- cheap. The P/E/growth (PEG) ratio is less than 0.5 -- again, cheap.

Our IU Value formula calls for buying profitable and growing companies when their valuation is lower than their growth rate on a P/E basis. That's Barrick in a nutshell.

I have bought Barrick for my personal accounts, and I will buy it for our IU Model Portfolio (which is under water), as I will explain tomorrow.

The Barrick Blues

Barrick Gold has been hammered down to a 52-week low, even though its profitability is still high.

Why have gold miners been hammered? What's going on? There's another panic going on in the gold market. Gold has sold off about $200 in the last two months. It is nearly $400 off its all-time high of $1,900 an ounce last year, and it is now negative on the year. Gold miners have been slammed -- one of the worst-performing sectors in the market.

Why is this? I'm not really sure. First of all, it's not like the gold mining industry is a disaster. Most miners still have a cost of production below $1,000 an ounce, and with gold trading at $1,550 an ounce today, it's still very profitable for the major mining companies to dig the yellow metal out of the ground.

The price of gold has been pressured by a very strong dollar, which has been a product of a weak euro. This is a bit different from the dynamic last year, when gold rose as the sovereign debt crisis bubbled up. What's different this year? I think it's the fact that the latest monetary program, Operation Twist, will end next month, and the European financing operation known as the LTRO program is also done. The markets have been deflating as the free money programs from governments have expired. Less liquidity equals a lower gold price.

But this has all happened before. The market is worried that global governments are losing their political will to continue so-called quantitative easing programs. But do they really have any choice? At every point in the past as the banking crises have escalated, the world monetary authorities have had to step in and provide more liquidity. I think we all know where this path leads again.

Technically, gold has all the hallmarks of a climax selling bottom. In gold futures, the Relative Strength Index (RSI) hit 16, a one-year low. Each time the RSI for gold futures has gotten below 20, it's been the sign of a medium-term trading bottom. And as we know, gold has been in a long-term bull market. The onus is on the bears to prove to us that the bull market is ending. To raise questions about that, I would have to see more forceful selling below $1,500 an ounce.

Triple Bottom?

Each time the Relative Strength Index (RSI) reading for gold has gotten to 20 or worse,
that has marked a signficant bottom.

Now, as you may have noticed, similar technicals called for a buying opportunity last December, when gold last fell near $1,550. That worked out very well if you bought then and sold in March, when gold rallied back to nearly $1,800 an ounce. In fact, that action in itself could give the bears pause. We were down to $1,550, but gold was able to spring back $250 in two months. So, yes, it really is hard to keep tabs on this market!

That's all just macro-economic speculation, though. The real reasons I'm buying Barrick, as I said, are that I think gold will soon make a near-term bottom soon, and that Barrick has been unduly punished and is just way too cheap. Of course, the gold price could fall more, and the stock could get even cheaper, but I like it when I can buy a company with $6 billion in operating profits at a P/E of 7. It makes me feel good. So I own it now.

(Disclosure: The author owned Barrick Gold at the time of this writing. It will be added to the IU Model Portfolio at the end of trading today. Positions can change at any time.)