Ranting Andy: Juniors for Sale

RANTING ANDY – This week, gold industry leader Newmont Mining (NEM) agreed to purchase the junior exploration company Fronteer Gold (FRG, FRG.TO) for C$2.3 billion, representing a 37% premium to FRG’s closing price prior to the deal, and an all-time high price for FRG stock (see the gap up to $14.46 at the end of the chart below).

This transaction continues a trend that will only accelerate in the coming years, as major mining companies endure the stock multiple dampening effects of resource depletion.  Global gold production peaked in 2003 when the price was just $350/ounce, at roughly 2,600 tonnes/year.  However, due to gold’s natural scarcity, rising extraction costs, lengthened permitting periods, a lack of exploration capital, and incessant naked shorting of junior miners, production has incredibly fallen by roughly 1%-2% since then despite a quadrupling of the gold price.  

Despite the higher gold price, which should continue its upward trajectory in the coming years, the aforementioned factors will preclude global gold (and silver) production from materially improving into the foreseeable future.  Hence, the onset of the M&A machine, which when all is said and done should repeat the experience of the Oil Exploration & Production sector in the late 1990s/early 2000s. 

Crude oil faces the same depletion and cost issues as gold, except that its overt Cartel, OPEC, is charged with SUPPORTING oil prices, while gold’s covert Cartel has been charged with SUPPRESSING them.  Once global capital started to enter the Oil & Gas sector en masse in the mid 1990s, reliquefying it after a 15-year depression, the ensuing frenzy of M&A activity rivaled any seen in the history of financial markets.  I remember seeing a chart of the top 30 Canadian E&P companies in roughly 1998, and then a follow-up table showing that only THREE remained in roughly 2004.

The same thing WILL happen in the Precious Metals space over the next decade, and 2010’s largest deals (KazakhGold/Polyus Gold, Kinross/Redback, and Newcrest/Lihir) will be DWARFED by the size of deals coming down the pike, particularly when the world’s largest gold producers get aggressive, as Newmont did this week.  As well as sovereign wealth funds, particularly in China, India, Russia, and the Middle East.  For the record, the 10 largest global gold miners are: 

Given that the top ten global producers are responsible for a measly 39% of global production, one can see just how fragmented this industry is, and just how ripe for consolidation, particularly as none of the top four companies, or five of the top seven, have made a material acquisition in eons (the last major deals being Anglogold/Ashanti in 2004 and Barrick/Placer Dome in 2006). 

Can you imagine, the world’s best performing asset over the last decade, and BARELY ANY material M&A activity?  Of course, it didn’t help that this group, particularly Barrick and Anglogold Ashanti, had been advised by their bankers to HEDGE PRODUCTION over the past decade at historically low gold prices, rather than PURCHASE DEPRESSED ASSETS!

Until this week’s NEM/FRG deal, none of the top four gold mining companies had made a material acquisition in more than five years, and for that matter neither has Goldcorp, the world’s seventh largest and arguably owner of the world’s most profitable gold mine, Red Lake.  Moreover, for the C$2.3 billion price tag, Newmont did not even acquire any current production, as none of FRG’s properties are anticipated to commence production until at least 2014!

Sound business practice dictates to buy low and sell high, but observation of the history of M&A activity, as well as human nature in general, tells a conflicting story.  Kudos to Kinross for the foresight they showed in recent years, aggressively building stakes in junior mining companies and pulling the trigger on major acquisitions such as Bema Gold (2007), Aurelian Resources (2008), Underworld Resources (2010), and Redback Mining (2010), launching it into the top echelon of global gold miners.  Sadly, however, most of the others sat on their hands during this period of historically low asset valuations, watching their respective production rates deplete and costs rise while mining sector valuations have again started to rise.  By the time shareholder/BOD pressure pushes them into aggressive M&A action, I believe the majority of their targets will have doubled, tripled, or more in price. 

As the gold bull market explodes in the coming years, large-scale production projects will become prohibitive to all but the financially strongest companies.  Thus, I estimate that by roughly 2015 the top ten gold producers will control 60%-70% of the world’s resources, suggesting a dramatic M&A pace rivaled only by what occurred in the E&P sector over the 1997-2007 period.

And one final note for those interested in the details of the NEM/FRG merger.  Fronteer’s main properties are in Nevada, centered around one of the world’s most prolific gold mining districts, the Carlin trend (see map below). 


Aside from being well-endowed with relatively low-cost gold (although still subject to major permitting issues), Nevada is one of the world’s most friendly mining jurisdictions.  Not to mention that the world’s two largest gold miners, Newmont and Barrick, are major producers there.  In other words, I believe the coming M&A frenzy for quality Nevadan gold mining juniors will be one for the record books.


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