How Much Glitter Does Gold Add to Freeport’s Stock?

Freeport McMoran Copper (NYSE:FCX) is involved in mining, smelting and refining of coper, gold and molybdenum. The company runs its mining and smelting operations in North and South America, Indonesia and Africa. Freeport competes with other miners such as Southern Copper (NYSE:PCU), Codelco and Newmont Mining (NYSE:NEM).

Freeport’s extensive copper mining operations are its biggest source of value – more than 73% of our $63.42 base price estimate for Freeport’s stock. Our price estimate currently stands about 25% ahead of market price. The company’s mining and production of gold makes up for most of its remaining value. Here we try and explain how the outlook for gold prices in the years to come can affect Freeport’s stock price.

Freeport’s Gold Operations

Freeport sold about 1.9 million ounces of gold in 2010. The company’s sale of gold hit a high point in 2009, at more than 2.6 million ounces. While these numbers might appear large, they are quite small when compared to those of Barrick Gold (NYSE:ABX), the leader in the gold industry. Barrick’s gold sales in 2010 totaled almost 7.5 million ounces – almost 4 times that of Freeport.

But gold will be a bigger source of value for Freeport in the years to come – primarily because of Freeport’s Indonesian mine that boasts the largest single recoverable reserves of gold compared to any other mine in the world. This mine had proven reserves of 33.7 million ounces in 2010 – enough to sustain Freeport’s production at current levels for at least 12 more years.

The Outlook for Gold

Gold prices have rallied substantially in the past few years, with the price per ounce of gold rising from just about $600 in 2007 to more than $1400 now – a 133% increase. ^[1] This can be explained by the fact that the global economic recession forced investors to look for alternatives to the capital market. Commodities – more specifically silver and gold – are the perfect substitutes in weak economic situations like the one witnessed recently.

But this also means that as economic conditions strengthen, the demand, and hence the price, of gold will not see much growth. The current price of gold future contracts hint towards gold prices being stable around $1400 per ounce till the end of 2012. ^[2] Prices could then increase by about 15% to cross $1600 per ounce by 2016.

We estimate a 10% annual growth in Freeport’s realized price per ounce of gold.

But if the prices only reach $1600 per ounce by 2016, this would imply downside of more than 9% to our $63.42 price estimate for Freeport, dropping our number below $59.

See our full analysis and $63.42 price estimate for Freeport McMoran

1. Gold Spot Prices, Gold Price, 2011 [↩]
2. Gold Futures Price, Quote.com, Mar 16 2011 [↩]