Tuesday, September 07, 2010

Digging for Gold Among the Miners

By Eric Jackson
RealMoney Contributor

9/7/2010 11:30 AM EDT
Click here for more stories by Eric Jackson

There's been a lot of excitement about the mergers-and-acquisitions action in the tech sector lately. That has naturally spurred a great deal of speculation as to what other companies might be taken out next -- and, currently, those same dynamics are also present in the gold sector.

Last week, Goldcorp (GG - commentary - Trade Now) announced it had agreed to buy Andean Resources for roughly $3.46 billion, topping another bid from Eldorado (EGO - commentary -Trade Now). Australia-based Newcrest Miningrecently completed its purchase of Lihir Gold, a deal that was worth some A$9.5 billion as of early May. Additionally, Kinross Gold (KGC -commentary - Trade Now) agreed to buy Red Back at the start of August.

We're likely to see a number of similar deals to come, wherein the big gold players -- names such asBarrick Gold (ABX - commentary - Trade Now), Goldcorp, and Newmont Mining (NEM - commentary -Trade Now) -- look to buy assets of some of the junior gold miners.

Why will these gold majors buy now? There are several reasons:

  • They have the cash and currency to do so. Just as in the word of large-cap tech, these large majors weren't doing deals two years ago when the walls were closing in on the global economy. The market hasn't returned to the 2006 buyout binge days, but the stock market has at least recovered enough to make the head honchos sufficiently confident to green-light deals.
  • The price of gold is near $1,300 an ounce. If you were a CEO of one of these large majors, you'd think twice before going to your board to buy an attractive junior at a time when the price per ounce of gold had collapsed (as had been the case in early 2009). You'd know that would be a tough sell, and that a few directors would be likely to ask, "What's the rush?" The higher price at this point means these boards will likely feel more confident in the economics of buying these assets.
  • A physical scarcity of gold has made these juniors even more attractive. There are 162,000 tons of gold in the world. That's it. Printing presses can't print more gold. Therefore, given that gold prices are hovering near all-time highs and that some are predicting event stronger upward moves, it makes sense for these large majors to act now and get a piece of the action.
  • These large majors need to add reserves each year. Barrick, in 2009 alone, produced 231 tons (or 7.4 million ounces) of gold -- which means it reduced its reserves by that amount. These large players need to keep filling the top of their reserves funnel in order to show their investors that they are keeping their reserves high. They can't do that through new finds by themselves. They need M&A.

So, as to the virtually certain coming tide of consolidation in the gold space, I like these juniors:

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