Gold to hit US$15,000. Wait, what?
It’s clear that merger mania has broken out in the gold mining industry.
In recent months, we’ve seen the merger of Barrick Gold (the world’s second-largest gold producer by market capitalisation) with Randgold Resources (the world’s ninth-largest gold producer).
The Barrick-Randgold deal was announced on 27 September 2018 and completed on 31 December 2018 at a valuation of approximately US$6.5 billion.
The next blockbuster deal was the acquisition of Goldcorp (the world’s eighth-largest producer) by Newmont Mining (the world’s largest producer), announced on 14 January 2019 with a valuation of about US$10 billion.
With four of the world’s 10 largest gold producers engaged in multibillion-dollar mergers, the floodgates are now open for scores of mergers and acquisitions in the ranks of mid-sized and junior companies in gold mining and gold royalties.
High gold prices = more mergers
Your strategist in a core shed in the Val-d’Or gold mining region of Quebec, Canada. The cores (displayed as horizontal slabs) are obtained from drilling operations on promising sites for gold mines. They are analysed for gold content, and the data are used in feasibility studies for new mines.
Recent higher gold prices are an obvious catalyst for mergers and acquisitions of companies with significant proven reserves and operating mines.
This is especially true in an environment where discoveries of new reserves are scarce and the concentrations of gold in existing reserves are low.
The single most important factor in the forecast is not the higher price of gold but the economies of scale and efficiencies that arise from combining successful gold producers.
When two major gold producers merge, the economies of scale are obvious.
While hands-on mining expertise may be required at each mine, it is straightforward to eliminate duplication in head office and regional office staff in terms of executives, lawyers, HR personnel, finance professionals and other staff functions.
Discounts from outside vendors can also be arranged when the volume of business goes up.
This applies to everything from feasibility studies to travel and entertainment.
The result is an immediate increase in earnings per share, which attracts new investors, including those who have not traditionally invested in the mining sector.
Current reserves more valuable than before
Another driver is the difficulty in finding new high-quality reserves.
Gold output has been flat for the past several years.
Part of this is due to the shut-in of mines after the 2011-13 gold price collapse and resulting bankruptcies of marginal or overleveraged producers.
Much of that capacity has since been absorbed by new mining companies seeking a lower cost structure and purchasing distressed assets for cents on the dollar.
That game of musical chairs is now over.
It has resulted in some of the shut-in capacity coming back online, but it has not resulted in large-scale new capacity.
Gold has always been scarce and difficult to mine (that’s the attraction).
But in recent years, it’s almost impossible to find new reserves.
This makes existing reserves more valuable and drives companies to increase their share price through financial engineering rather than new output.
Complementing the decreased or flat supply is steady and increasing demand. Russia and China have officially added 3,000 metric tonnes of gold to their reserve positions in the past 10 years.
The actual figure is likely higher because China is non-transparent about its official holdings.
Other nations are also adding to their gold reserves, including Turkey, Iran, Mexico and Vietnam.
Official sales of gold by developed economies, central banks and the IMF stopped cold in 2010 (with the exception of trivial sales by Canada, which now has no official gold at all).
The bull market continues
This imbalance of supply (flat) and demand (growing) has put a floor under gold prices independent of other price factors, including real interest rates and investor sentiment.
The asymmetry of price volatility in favour of rising prices puts proposed merger deals on strong ground.
Another factor is the increase in the number of gold mining companies whose stock prices are trading at premiums to book value.
These companies can use their stock as currency to buy competitors. The result is accretive to earnings per share and adds another vector in favour of doing such deals.
Another driver of merger and acquisition activity in the gold mining industry is geographic diversification.
Many attractive sites for gold mining suffer from geopolitical uncertainty or risk of social unrest.
These locations include Russia, Venezuela, South Africa and the Congo.
Gold (US dollars) – six months
Finally, the most powerful driver of gold mining merger and acquisition activity is simply the fact that gold has entered a new bull market phase, which may boost the price of gold to US$5,000 per ounce or higher, if the last two gold bull markets are any indication.
It’s important to understand that you cannot make money in gold when the world is on a gold standard.
A gold standard means a fixed relationship between gold and the leading trading currencies.
Gold was pegged to the dollar at US$35 per ounce in 1933 and remained there until 1971.
The price did not fluctuate and there was no dollar profit to be made in gold (something to keep in mind the next time some gold bug pounds the table and demands a gold standard).
The way to make (or lose) money in gold is when there is no gold standard and the US dollar price of gold fluctuates.
The first bull market after 1933 ran from 1971-1980. Gold rose 2,200%, from US$35 per ounce to US$800 per ounce.
This was followed by a prolonged bear market from 1980-1999 when gold fell from US$800 per ounce to about US$225 per ounce — a 72% decline over 20 years.
The next bull market ran from 1999-2011, during which time gold rose from US$225 per ounce to US$1,900 per ounce — an 845% rally.
This was followed by a second bear market from 2011-2015 when gold fell 55%, from US$1,900 per ounce to US$1,050 per ounce in December 2015.
The new bull market, the third in the past 50 years, began on 15 December 2015 and continues today. So far, gold has rallied 25% off that December 2015 low.
The first bull market (1971-1980) ran for nine years.
The second bull market (1999-2011) ran for 12 years.
Averaging those two rallies suggests the new rally could run for about 10 years, which would last until December 2025.
A 1,500% gain (about the average gain of the two prior bull markets) would put gold at US$15,000 per ounce by 2026.
It’s not necessary to reach that conclusion to see the huge upside potential for gold prices in this new bull market.
That’s why major gold miners are eager to acquire their competitors at current attractive valuations.
All the best,
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