The
world’s two biggest gold miners both announced mega-mergers over the
past 5 months or so. These huge deals briefly garnered some
interest in the usually-forgotten gold-stock sector, and fleeting
praise from Wall Street analysts. But gold-stock mega-mergers are
bad news for gold-miner shareholders on all sides. They reveal the
serious struggles of major gold miners, and really retard future
upside in their stocks.
For
decades the largest gold miners in the world have been Newmont
Mining (NEM) and Barrick Gold (ABX). These behemoths have long
dwarfed all their peers in operational scope. While the gold miners
are in the process of reporting Q4’18 results now, their latest
complete set remains Q3’18’s. As after every quarterly earnings
season, I analyzed them in depth for the
major gold miners
of GDX back in mid-November.
The
GDX VanEck Vectors Gold Miners ETF is the world’s leading and
dominant gold-stock investment vehicle. In Q3 alone NEM and ABX
mined a staggering 1286k and 1149k ounces of gold! To put this in
perspective, the average of the next 8 largest gold miners rounding
out the top 10 was just 508k ounces. Newmont and Barrick have long
been in a league of their own, with commensurate market
capitalizations.
In
mid-November NEM and ABX were worth $17.1b and $14.9b, granting them
massive 11.0% and 9.5% weightings within GDX. These two gold giants
alone accounted for over 1/5th of GDX! That gives them outsized
influence in not only that ETF, but in the entire gold-stock
sector. GDX is the sector benchmark of choice for gold stocks these
days, so the fortunes of NEM and ABX stocks really affect overall
performance.
Gold-mining stocks are generally divided into three tiers based on
their production. Anything over 1000k ounces annually is considered
a major, which works out to 250k per quarter. NEM and ABX produced
so much gold in Q3 they exceeded this threshold by a colossal 5.1x
and 4.6x! They are really super-majors. Mid-tier gold
miners produce between 300k to 1000k ounces every year, while
juniors are under 300k.
Back
on September 24th, 2018, Barrick Gold shocked the gold-stock world.
It announced it was merging with Randgold (GOLD), which was really
an all-stock acquisition of GOLD by ABX worth $6.5b. Barrick
shareholders would own 2/3rds of the new combined company, while
Randgold’s would own the rest. To avoid confusion, this essay uses
the classic ABX and GOLD stock symbols to represent Barrick and
Randgold.
ABX
had been Barrick’s ticker for decades, but was just recently
abandoned on January 2nd. With this mega-merger finished, the new
company took over the excellent GOLD symbol going forward. That is
a wise decision, as anyone who types “gold” into any brokerage
account will see Barrick Gold. Years ago before Randgold got that
coveted symbol, another major miner had it and really seemed to
benefit from it.
In
Q3 Randgold was the 10th-largest gold miner in the world producing
309k ounces. Added on top of Barrick’s 1149k, the new combined
1458k would take back the top-gold-miner crown from Newmont which
produced 1286k that quarter. Apparently size matters a lot when
you’re a gold-mining executive. But with both ABX and GOLD
suffering chronic declining production, that mega-merger reeked of
desperation.
Newmont’s leadership wasn’t happy with losing the pole position
among global gold miners. So it soon got to work on looking for a
mega-merger of its own. On January 14th, NEM announced it was
acquiring major miner Goldcorp (GG) in an all-stock deal worth
$10.0b! That looked like one-upmanship taking it to Barrick. NEM
and GG shareholders would own about 2/3rds and 1/3rd of the new
combined colossus.
Goldcorp was the world’s 7th-largest gold miner in Q3’18, producing
503k ounces of gold. Added on to Newmont’s 1286k, that creates a
new monster running at an unprecedented 1789k-ounce quarterly
rate! If bigger is better, these new combined super-major gold
miners ought to be the best seen in history. But unfortunately in
gold mining that isn’t true, and these new giants will likely fare
worse than if they hadn’t merged.
In
their merger announcements, the CEOs of all 4 of these major gold
miners tried hard to sell their deals as wonderful news for
shareholders. They argued that synergies and cost savings would
make these new combined titans more effective at producing superior
returns for their shareholders going forward. And as always with
any large merger, Wall Street analysts universally applauded these
mega-mergers as good.
Sadly the opposite is likely true, these deals are bad news
for all the owners of Newmont and Barrick as well as former owners
of Goldcorp and Randgold. These new giant super-majors are even bad
news for the gold-mining sector as a whole. The odds are really
high that their stocks will really underperform the smaller major,
mid-tier, and junior gold miners in coming years. That will hurt
this entire sector on multiple fronts.
Contrary to their CEOs’ marketing propaganda, none of these four
major gold miners approached these deals from positions of
strength. They’ve all been struggling with weakening production
and rising costs. Gold mines are wasting assets that are constantly
depleting, and it is increasingly challenging to find new gold to
mine economically at the scale and pace the majors need. These
mergers didn’t solve that core problem!
This
table looks at the quarterly production, its year-over-year change,
and all-in sustaining costs per ounce mined of Barrick, Randgold,
Newmont, and Goldcorp during today’s
secular gold bull.
It started in late Q4’15 out of deep 6.1-year secular lows in gold.
Barrick deleted Randgold’s old website, so there is no Q4’15 GOLD
data. And as of Wednesday afternoon NEM and GG hadn’t yet reported
full Q4’18 results.
Barrick and Newmont didn’t just effectively dilute their
shareholders by 50% for some relatively-meager cost-saving
synergies, but because they can’t grow their production
internally. ABX’s gold mined each quarter has been falling sharply
on balance for years! It has seen brutal YoY drops as high as
25.5%, which ought to be impossible for a world-class gold major. 7
of the last 9 quarters have seen big declines.
Barrick’s average quarterly production since Q4’16 plunged an
astounding 8.6% YoY. The reason Barrick’s management blew $6.5b in
stock buying Randgold is they desperately needed more production to
mask the precipitous drop in their own. Barrick’s total 2018
production of 4525k ounces was 18.0% below the 5516k it mined only a
couple years earlier in 2016. At best adding Randgold just regains
those losses.
And
GOLD has been suffering the same production struggles as ABX. Over
its past 4 reported quarters, Randgold’s gold mined has fallen an
average of 7.4% YoY. Can bringing two rapidly-depleting major gold
miners together magically make a stronger one? I doubt it.
Barrick’s reported production will enjoy a big temporary boost for
its first four quarters as a merged company, and then waning
production will again be unmasked.
While the new giant Barrick will have more capital to develop new
gold mines and expand existing ones, it seems unlikely that will be
enough to turn this super-major around. Barrick and Randgold
operated about 12 and 4 gold mines respectively pre-merger. So
bringing another few online in coming years might not move the
needle enough to outpace depletion. And it takes over a decade to
permit and build new mines.
The
entire gold-mining industry has been greatly starved of capital
largely since 2013, with 2016 being a modest exception. Thus the
big investments necessary to find new large-scale gold deposits and
slowly advance them to mine builds have been severely lacking. So
this whole industry’s pipeline of new gold to mine has been
crippled, all but pinched shut. Declining miners merging does
little to solve this problem.
Newmont has fared way better than Barrick in recent years, actually
enjoying strong production growth on balance from Q4’16 to Q4’17.
But this past year even mighty NEM has started to suffer from waning
gold production. It averaged 5.9% YoY declines in the first three
quarters of 2018. I suspect NEM is just a little behind ABX in
rolling over into depletion outpacing mining growth. ABX’s merger
forced NEM to act.
While Goldcorp was long celebrated as the world’s best major gold
miner, it has been struggling for years with slowing production.
Over the last 9 quarters GG only saw one modest production gain,
with its gold mined dropping a colossal 11.0% YoY each quarter on
average! So although GG produces about twice as much gold as
Randgold, it might be a worse acquisition target due to its faster
pace of shrinking production.
Like
ABX and GOLD, it’s hard to imagine combining two more weakening
majors NEM and GG will yield a way to stop and reverse their falling
production. Again for their first four quarters together this new
giant Newmont will appear to see big annual production growth. But
once that post-merger comparison rolls past, the declining gold
across all its mines will again be revealed. Mega-mergers can’t
negate mine depletion.
Randgold didn’t even bother reporting industry-standard all-in
sustaining costs, which is why they’re not included above. But its
cash costs were often on the high side, so it’s likely the new
combined company will drag overall mining costs higher. Barrick’s
major-leading low AISCs aren’t likely to last with GOLD’s mines
thrown in the mix, which means higher costs and lower overall
profitability for Barrick going forward.
Newmont should benefit more from Goldcorp’s lower cost structure. NEM
averaged $975 AISCs in the first three quarters of 2018, way higher
than the $877
average in Q3’18 among the GDX gold miners. GG’s AISCs averaged
$886 over that 9-month span, so the new combined Newmont should
benefit from lower costs. But that may not last long, as weakening
production eventually pushes per-ounce costs higher.
Gold-mining costs are largely fixed quarter after quarter, with
actual mining requiring the same levels of infrastructure,
equipment, and employees. So slowing production yields fewer ounces
to spread mining’s big fixed costs across. If these new super-major
gold behemoths can’t arrest their depleting production, their costs
will inevitably rise in the future hurting profitability. Again
these mega-mergers didn’t solve that problem.
So
it looks like the managements of Barrick and Newmont just issued
$6.5b and $10.0b of new stock so they could report big merger-driven
production surges for a single year! Once those pre- and
post-merger year-over-year comparisons pass, the vexing
waning-production problems at all four of these predecessor gold
miners will again become apparent. But that’s not even the biggest
reason these mergers are bad news!
Even
before these mergers as apparent in mid-November when I analyzed
Q3’18 results, both Newmont and Barrick already had very-large
market capitalizations of $17.1b and $14.9b. That again granted
them massive 11.0% and 9.5% weightings in GDX. Like most stock
indexes and ETFs, GDX’s components are weighted by market cap.
Goldcorp and Randgold ranked 6th and 7th then in market cap and
weightings.
Adding NEM and GG together as of mid-November would catapult their
market cap and GDX weighting to $25.1b and 16.0%. Adding ABX and
GOLD together yields a similar $22.3b market cap and 14.5% total GDX
weighting. So these two super-majors alone could account for a
crazy 30.5% of GDX’s weighting! That is almost scarily
concentrated, although we don’t yet know how GDX’s managers will
deal with this.
As
of this week the new combined Barrick only has an 11.1% GDX
weighting, while Newmont is at 8.2% since its mega-merger is not yet
consummated. It will be interesting to see whether the new
companies’ weightings going forward are kept in market-cap
proportion or somehow limited. I hope it’s the latter, as many of
the other gold miners in GDX have far-better growth prospects than
these new super-majors.
ETF
weightings aside, higher market caps create plenty of
problems of their own. I’ve written essays in the past on
picking great
gold stocks, and surprisingly market capitalization is the
single most important factor for future gains. The gold stocks with
the largest market caps usually significantly underperform their
smaller peers. These new super-majors are so darned big that they
really compound this problem.
In
mid-November when I analyzed the GDX miners’ Q3’18 results, the
average market cap of its top 34 component stocks was $4.3b.
Excluding NEM and ABX, that fell to $3.5b. It takes proportionally
more capital inflows, investors buying shares, to push a larger
stock higher than a smaller one. If the super-majors are worth
$24b, it takes 6x as much buying of their stocks to drive the
same gains as on a $4b company!
Imagine the different forces involved turning a supertanker versus a
tugboat. The bigger any stock in the stock markets, the more
inertia it has and thus the more capital is needed to overcome that
and move the stock. And market-cap issues are not just a size thing
in gold stocks. Smaller major, mid-tier, and junior gold miners
have way fewer gold mines and much-lower production, which makes it
far easier to grow output.
While Newmont is a temporary exception since it was bucking the
major trend and growing production in 2017, Barrick, Randgold, and
Goldcorp all really underperformed their sector in recent years.
This chart looks at the indexed performance in ABX, GOLD, NEM,
and GG stocks compared to the leading sector ETFs of GDX and the
smaller GDXJ which largely tracks
mid-tier gold
miners under 1m ounces annually.
Both
GDX and GDXJ fell to all-time lows back in mid-January 2016 when
this gold-stock bull was born. So all 6 stocks are indexed to 100
as of that day, revealing their relative performance since. Despite
their heavy weighting in GDX, the major gold miners generally lag
their key sector benchmarks. ABX, GOLD, and GG have really
struggled in recent years as their managers failed to stem big
production declines.
This
chart is pretty damning, showing why the managers of Barrick and
Newmont are desperate to show rising production even if only for a
year after their wildly-expensive mega-mergers. ABX and GOLD have
both been really underperforming their peers, scaring investors away
while putting serious pressure on managements to turn things
around. NEM resisted that, but its production started to decline
too in 2018.
And
GG has been a basket case, actually managing to fall below its deep
secular lows of early 2016 in recent months! That’s a sad fate for
what was the world’s best major gold miner for many years. NEM
buying this dog is likely to drag down NEM’s stock performance to
some midpoint between what it has done and how GG has fared. For
the most part the largest gold miners haven’t been good
investments.
The
much-larger market caps coming from combining struggling majors into
super-majors is highly likely to exacerbate this underperformance
trend. The new Newmont and Barrick are way bigger and far more
ponderous, and will require a lot more share buying to move their
stock prices materially higher. But why will most investors even
bother to buy these titans when many smaller mid-tier gold miners
are thriving?
This
next chart adds a single additional mid-tier gold miner to
illustrate their outperformance. I chose IAMGOLD (IAG) for this
example for a couple reasons. It produced 882k ounces in all of
2018, which makes it a larger mid-tier gold miner nearing that
1000k+ major threshold. And IAG is unremarkable fundamentally. It
mined the same 882k ounces in 2017, so there was no production
growth at all last year.
And
its 2018 all-in sustaining costs are expected to come in on the high
side near $1070 per ounce, which is worse than most of the majors.
So there’s really nothing special about IAG operationally suggesting
it should far outperform. If I wanted to cherry pick, there are
other mid-tier miners that have trounced what IAG has done in recent
years. Yet even IAG wildly outperformed the majors and sector ETFs
during this gold bull.
If
Newmont and Barrick were the only gold-mining stocks, they’d
certainly be worth owning during a secular gold bull. But why own
these massive supertanker-like gold miners when smaller major,
mid-tier, and junior gold miners’ stocks are performing way better?
The smaller miners not only have lower market caps easier to bid
higher with much-smaller capital inflows, but plenty also have
superior fundamentals.
They
tend to have just a few or less gold mines, making it much easier to
grow production by expanding existing mines or building new ones.
Those expansion events act as major psychological catalysts to get
investors interested in those stocks, fueling
disproportionally-large buying to catapult them higher. There is
really no reason to deploy capital in large majors when mid-tiers
are easily running circles around them.
Even
if like me you don’t own Newmont or Barrick and have no intention of
investing in them, they could cause problems for the entire
gold-stock sector. Their hefty GDX weightings mean their stocks
have way-outsized influence in how that leading ETF fares. If these
super-majors’ giant stocks lag, they are going to retard GDX’s
upside which in turn will leave traders less optimistic and more
skeptical on gold miners’ outlook.
So
mega-market-cap gold miners could significantly slow the overall
sentiment shift from bearish back to bullish which is necessary to
attract in buying. If capital inflows diminish because of the
perception this sector isn’t rallying enough, the bull-market
uplegs will unfold slower and maybe end smaller. Even more
problematic, the super-majors’ high weightings in GDX suck ETF
capital away from more-deserving miners.
Most
investors prefer sector ETFs over individual stocks, so lots of
capital will flow into GDX as investors get interested in gold
stocks again. GDX’s managers have to allocate any differential
buying pressure into its underlying component companies in
proportion to their weightings. The newly-merged Barrick and
Newmont will likely command much-bigger weightings, starving smaller
component miners of capital inflows.
But
despite these mega-mergers being bad for everyone except the
managers of those companies paying themselves huge compensation, all
is not gloom and doom. If the new Newmont and Barrick continue to
suffer waning production after their initial merger-boost year,
investors will shift capital out of them into the other gold
miners. That will gradually throttle their market caps and thus
weightings in GDX, mitigating damage.
And
if these super-majors taint the performance or expected upside in
GDX enough, GDXJ may very well usurp it as the gold-stock
sector benchmark of choice! While falsely billed as a Junior Gold
Miners ETF, GDXJ has really become a
mid-tier gold
miners’ ETF. It has been
increasingly
outperforming GDX, and that trend could accelerate since GDXJ
will hopefully never include the larger majors led by NEM and ABX.
With
so many fundamentally-superior smaller gold miners to pick from,
investors have no need to own the larger majors. Plenty of mid-tier
miners are still growing their production organically, by expanding
their existing mines or building new ones. Their upside as gold
continues marching higher in its bull market is enormous, dwarfing
what is possible in the giant majors struggling with waning
production. Avoid the latter!
One
of my important missions at Zeal is relentlessly studying the
gold-stock world to uncover the stocks with the greatest upside
potential. The trading books in both our
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The
bottom line is gold-stock mega-mergers are bad news for everyone in
this sector. Combining major gold miners already struggling with
slowing production doesn’t solve the problem, but only masks it for
a single year. The resulting super-majors’ massive market
capitalizations saddle their share prices with big inertia. They
are going to require much-larger capital inflows to rally
materially, really retarding their upside.
Their higher weightings within sector ETFs will lead to worse
perceived sector performance, delaying the necessary sentiment shift
from bearish back to bullish. And the super-majors will suck up
more of the capital allocated to gold-stock ETFs, starving smaller
and more-worthy gold miners of buying. Thankfully some of these
problems can be avoided by shunning Newmont and Barrick, and
sticking with great mid-tier miners. |