As the gold mining sector plunges to the end of a cyclical bear market, one
wonders if this ongoing selling climax will precipitate a catalyst for more
mergers and acquisitions in the industry. The last 12 years tells us that
these transactions tend to follow the market itself but with a lag. Peaks
in M&A activity (in global mining) in terms of number of transactions
and value occurred in 2006-2007 and 2010-2011 while troughs occurred in 2002
and 2008-2009. According to Ernst & Young, 2012 had the lowest number
of global mining deals since 2008 and the lowest in terms of value since 2009.
On a smaller microeconomic level, the current depths of the junior mining
industry and low share prices across the board should provide a catalyst for
more deal flow. Going forward I believe we will see industry consolidation
but in two separate different phases which will produce different winners.
The first phase should begin soon but will be the smaller phase. First we
should note that one reason it will be the smaller phase is because the market
is forcing the major producers to focus on execution, cash flow generation
and dividend growth rather than production growth itself. On a per share basis,
the majors have done a lousy job in terms of production growth. At the same
time, many majors have new CEO's who are unlikely to immediately take the
kind of risks that doomed their predecessors. Thus, don't expect the majors
to participate much in this initial phase.
The established small and mid-tier companies who have growth mandates and
posses financial strength and operational expertise will look to acquire quality
assets on the cheap or distressed assets for pennies on the dollar. Obviously,
the entire gold mining sector is going for fire sale prices right now and
especially the juniors. These companies seeking growth will first look to
see if quality junior-owned assets can be bought at a significant discount.
Second, they will look to acquire the junior companies that currently operate
underperforming mines (the distressed assets) which could be improved with
an injection of more capital or technical expertise.
The largest driver of this initial consolidation will be the failure of a
high percentage of junior companies. Through the brilliant work of John
Kaiser we know that the junior sector will shrink considerably in a Darwinian
sort of way. Simply put, too many of these companies have marginal prospects
and will not be able to raise the capital to survive this difficult environment.
The second phase won't begin until well after we see gold stocks (i.e GDX,
HUI) break to new all-time highs and confirm the breakout. This phase is at
least a few years away and could somewhat resemble the pac-man scenario, which
Eric King wrote about in 2004. Let me explain.
The gold stocks bottomed in Q4 of 2000. This bull market is currently in its
13th year. Two years from now it will be in its 15th year. Look at how much
capital has been deployed into exploration yet look at the pathetic results.
The exploration potential to add to production growth isn't promising and
requires too much time anyway. Secondly, the best assets will already be in
production. What else might you find after 15 years of a bull market, 15 years
of new mines going into production and 15 years of Billions being spent on
exploration? Factor in stronger share prices and its obvious why this will
be the phase when consolidation will heat up as producers acquire smaller
producers. It will be the easiest and the only way to get production growth
and reserve replacement.
What are the investment implications?
During the first phase the junior industry will contract substantially (as
many others before me have predicted). Many juniors will die off as they can't
raise the money to sustain themselves while the juniors with the best prospects
or with faltering productive assets will be acquired by the successful small
and mid-tier producers. For the most part, the winners in this phase will
actually be the acquirers who can add to their pipelines on the cheap and
thereby inevitably become more desirable for a larger company in the future.
In the latter phase (perhaps 2015-2016), you'll see the major and intermediate
producers acquiring mid-tier and large junior producers. In other words, M&A
activity will move up the food chain. Interestingly, in the final years of
the secular bull market we'll see more money chasing fewer companies. Unlike
in the first phase, the winner in this phase will be the companies that are
acquired. As for the short-term, we began scaling into positions last week
but maintain plenty of cash to be deployed (potentially) at our strong targets
of HUI 336 and HUI 300.
Good Luck!
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the producers and explorers poised for big gains in the next few years then
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