Canadian Mining Eye
An optimistic start with cautious overtones
The Canadian Mining Eye index gained 13% during Q1 2014 compared to an 8% loss during Q4 2013. The Canadian Mining Eye index outperformed the S&P/TSX Composite index, which gained only 5% during the first quarter. The London Metal Exchange index (LMEX) lost 6% during the quarter.
Canadian mining equities showed modest signs of improvement during the first quarter underpinned by commodity prices and continued cost focus of miners. While the majors continue to focus on rigorous cost control measures and disciplined M&A activities, juniors are still seeking the right opportunities.
- Gold prices gained 7% in Q1 2014 amid the Federal Reserve decision to reduce stimulus in measured steps, and increased demand from US and China. However, prices remained volatile as a result of changes in the global equity markets during the first quarter. While we saw an improvement in the price of gold, there are some analysts expecting gold prices to resume a declining trend.1 Gold prices are down 19% year over year.
- Copper prices remained volatile and lost 10% over the quarter on the London Metal Exchange (LME) due to concerns around decreasing demand from China, copper’s largest consumer.
- In the precious metals category, spot silver prices gained 2% over Q1 2014 underpinned by the demand for an alternative investment among the market participants due to uncertainty over global economic growth. However, silver prices are down 30% year over year.
Majors witnessed a gain of 10% in Q1 2014 compared to a fall of 2% in Q4 2013. Majors have already started experiencing some improvements in their operating performance with cost control measures carried out over the last few quarters. Barrick Gold reported a 14% decline in all-in sustaining costs to US$899 an ounce for the Q4 2013 compared to the same period in the previous year. Goldcorp reported an 11% decline in all-in sustaining costs to US$810 an ounce during the same period.
Opportunistic mergers and acquisitions
A number of companies are using the depressed state of mining stocks as a countercyclical opportunity to grow inorganically. During Q1, the Canadian mining sector witnessed a series of hostile takeover bids.
- Early in the quarter, Goldcorp made an unsolicited offer to acquire Osisko Mining for approximately CDN$2.6b. Osisko’s Board of Directors unanimously recommended rejecting the offer. Goldcorp offered to sweeten the offer by spinning off Osisko’s exploration assets. Meanwhile, Yamana Gold agreed to buy a 50% interest in Osisko’s mining assets on 2 April 2014. Osisko determined the implied transaction value to be CDN$7.60 per share. Goldcorp countered by increasing its offer to CDN$7.65 per Osisko share on 10 April 2014. On 16 April 2014, Yamana and Agnico Eagle Mines announced a plan to jointly acquire a majority of Osisko’s assets for an implied CDN$8.15 per share, representing an 11% premium to the current Goldcorp hostile bid. However, Yamana declined by 4% and Agnico fell 8% on the day of announcement, signalling the transaction to be dilutive for both acquirers. On 21 April 2014, Goldcorp stated that it would not amend its last offer in response to the Agnico and Yamana bid.
- HudBay Minerals made an all-share hostile offer for Augusta Resource in February 2014. Augusta Resource shareholders will receive 0.315 of a HudBay Minerals share in the deal. Augusta Resource views HudBay’s offer to be unrealistically low and not recognizing the fair value of its Rosemont project. Augusta Resource’s share price gained 27% after the deal announcement. However, the share price of HudBay Minerals has fallen by 6.1% after the deal was announced.
- We also witnessed some private equity interest in the sector during the quarter. For example, Waterton Precious Metals, a private equity fund focused on mining, made a hostile takeover offer to acquire Chaparral Gold for CDN$58.8m. Chaparral Gold viewed the offer to be inadequate. Meanwhile, Waterton Precious Metals has raised more than US$1b for its second precious metals fund to acquire distressed precious metal assets. Waterton Precious Metals fund hopes to capitalise on the decline in the valuation of mining assets. Notably, private equity investment in the mining sector has increased in recent years given the increasing difficulty faced by mining companies in accessing public markets and increasing interest of private equity investors in buying mining assets when they are relatively cheap.
Mining companies are opting for hedging to manage margins given the volatility in gold prices and increasing costs.
- For instance, Northern Star Resources announced a program to hedge 100,000 oz. gold production for one year at an average price of US$1,295.28 per oz. The company views this as a pragmatic and prudent strategy given volatile gold prices.
- OceanaGold entered into a zero-cost collar-hedging program2 for 208,000 oz. gold, which partly covers production from its Macraes open-pit and Frasers underground mines in New Zealand over the next two years.
Non-core asset disposal
Majors continue to dispose their non-core assets during the quarter.
- Barrick Gold completed several small divestitures during the quarter as a part of its portfolio optimization strategy. Barrick Gold completed the divestiture of its interest in its assets at Kanowna in Western Australia to Northern Star Resources for AUS$75m. In addition, Barrick Gold also divested 41m ordinary shares in African Barrick Gold for gross proceeds of US$188m. The company has also completed the divestiture of its minority interest in the Marigold mine in Nevada to Silver Standard Resources for US$86m.
The current depressed state of share and asset prices in the mining and metals sector provides companies with an opportunity to acquire assets at relatively lower prices. We do, however, see deal execution as a key challenge for transactions. The first quarter saw both Goldcorp and Yamana Gold battle for Osisko Mining, with at a late moment Agnico-Eagle partnering with Yamana. With multiple bids for Osisko Mining, some analysts, perhaps prudently, are sounding caution that buyers need to maintain a disciplined view to acquisitions so that they avoid overpaying. Meanwhile, more funds are likely to come into the sector from private equity players — attracted to countercyclical investing — in the form of patient capital.
While some mid-tier companies were able to tap equity capital, fund raising still remains challenging for juniors. Juniors must continue to be creative in their approach to raise money in the market. Companies with good quality assets with advanced projects are better positioned to raise funds. Companies opting for various financing options are likely to remain cautious to avoid unfavourable terms that could dilute shareholder value.
While some analysts expect positive movement in gold prices, uncertainty over metal prices persists and will continue to drive some companies to opt for hedging their future gold production. Hedging in a weak market is always a risky practice. Though we noticed several cost-saving initiatives among mining and metals companies over the last few quarters, cost control remains a key focus. Overall, we view the first quarter as a positive start for the year with modest strengthening of investor confidence levels for the sector.
1. Global Metals Playbook, Morgan Stanley, 8 April 2014.
2. In a zero-cost collar-hedging program, OceanaGold buys put options at a specific exercise price and finances them by selling an equal number of call options.