The most interesting news lately in the gold market is the $10bn take-over of Goldcorp by Newmont Mining. Coming only a few months after the merger between Barrick and Randgold, clearly there are some changes afoot in the mining sector. Outsiders used to M&A’s in equity bull markets may be surprised to hear that we believe these deals are borne out of grave concerns about the state of the world gold reserves and potential production going forward.
Ian Telfer, Chairman of Goldcorp commented last year that he thought that ‘all the gold in the world had probably been found’. The fact that there have been no major discoveries for years certainly adds weight to the story. While gold production has steadily gone up in the last decade, the big four miners that have become two, are crucially aware that they may only have enough reserves to mine for another 12-15 years. Exploration budgets have been low since the fall from the highs in the gold market in 2011 but still should have yielded more than they have done. Mining companies, in order to keep production growing have turned to the business of mining their higher-grade deposits. In the 1960s, the average reserve grade was 10g/tonne. Now, it is hovering around 1g/tonne for most, a fall of 90%. Clearly, ransacking the most profitable parts of your deposits is not a long-term viable strategy.
It’s a tough business, that is not getting any easier. Most of the 2500 mining companies are listed on the Toronto Stock Exchange, where Canadian brokers have been the major fund raisers in the industry for decades. Unfortunately, the dire investor returns in mining, saw brokers, first turn to cryptocurrencies, then to cannabis as the new investment stories, looking for financing.
The harsh reality is that the current gold price of $1280/oz produces very little free cash flow for most miners, certainly nowhere near enough to replace reserves by exploration or acquisition. The chart below of Goldcorp’s retained earnings is enough to make investors weep, but it could be repeated over most of the industry apart from Randgold, which has long stood out as one of the few profitable gold companies, due in no small part to the exceptional CEO, Mark Bristow, who has never comprised on grade. It will be interesting to see the developments in the new merged Barrick-Randgold with him at the helm. While investors are no doubt happy to see a 15% premium paid for their Goldcorp shares, the $10bn price tag is a long way short of the $45bn market capitalisation in 2011.
Whether peak gold has been seen or is happening now is less relevant than the potential rate of drop off in future years. The oil industry has seen the development of fracking to new, previously inaccessible and uneconomical reserves in recent years. The gold mining industry has not enjoyed the same developments. These recent mergers of the majors should be seen as a loud alarm bell. Sometime, in the coming years, the ability to produce gold and replace gold reserves will be significantly tested. The resulting impact of the gold price itself may finally be the dreams of long-term gold bulls. As the price of gold rallies so will your purchasing power as long as you are invested in gold. One great way to immediately see your purchasing power soar is to download Glint!