The global gold frenzy
(As originally appeared in Canadian Mining Journal, December 2010
By Blake Langill, Assurance Partner and Leader, Toronto Mining practice, Ernst & Young LLP
The global mining and metals industry has seen approximately 383 deals with a cumulative value of $26.5 billion to the end of October 2010. The gold industry appears to be frenzied as the commodity accounts for 40% of all deals in the sector by quantity and 31% by value worldwide.
Domestic consolidation is driving recent activity with 55% of gold deals targeting domestic reserves and market share growth. The top two deals that took place in Q3 of this year include two friendly transactions: Newcrest Mining Ltd.’s $9 billion acquisition of fellow Australian Lihir Gold Ltd. and Kinross Gold’s $6.8 billion acquisition of Red Back Mining Inc. An all-Canadian transaction, the acquisition of Red Back was a move to complete the “engagement ring” after Kinross’ initial 9.3% investment in Red Back.
Canada is enjoying a front row seat to this gold frenzy, not only as an investment destination but in terms of significant investor nationality. By volume, 39% of all gold deals took place in Canada with 49% of all deals conducted by Canadian companies. We believe this high level of transaction activity in the gold industry will continue into 2011 due to market fundamentals, as well as several industry factors and trends. The two key factors to continue to watch are supply and demand. Leading indicators to monitor include investment demand, particularly from exchange-traded funds (ETFs), and the long-term cash cost curve.
From the demand side of the economic equation, investment demand for gold increased 118% in 2010 from the previous year, while jewellery demand decreased by only 5% despite consumers’ reactions to surging price levels. Ongoing economic uncertainties including weak governmental balance sheets in the EU and the U.S. continue to attract investors to gold as an opportunity to diversify risk and enhance consistency on their returns. These are two strong facts supporting the case for strong demand for gold.
On the supply side, the World Gold Council reported a year-over-year increase of 18% with all components of supply making a positive contribution compared to previous year levels. However, while supply has increased, there continues to be pressure on the costs to bring new mines into production and on cash costs of production.
The other significant factor supporting further consolidation is the relative size of the gold companies. It’s worth noting that the top 10 global gold producing companies account for 40% of world production. To replace existing resources and production, many of these producers will need to make acquisitions to ensure they remain on the growth curve that investors are demanding. Unfortunately, when it’s time for companies to “move the needle” in terms of reserve growth, there are fewer world-class deposits at the advanced development stage. This makes the competition for these deposits increasingly competitive. Goldcorp’s proposed $3.6 billion acquisition of Andean Resources Corp demonstrates the size of premium that may be available for shareholders of companies who hold a “Cerro Negro” quality asset.
In terms of future trends, we expect a significant number of deals to occur in Latin American countries, in particular Chile, Brazil, Peru and Coloumbia. West Africa and Mexico also remain as future areas of growth, but companies must consider the resource nationalism risks and their ability to maintain a social licence to operate.
There is also a strong possibility that the drive for gold reserves will cause gold companies to seek out non-core properties or high gold content properties (for example, copper-gold properties) from base metals companies.
With future trends demonstrating offshore interest and the continued drive for reserve growth, we anticipate further high levels of merger and acquisition activity in the gold sector, particularly “friendly” equity transactions. With pending transactions like Goldcorp and Andean on the table and long-term supply and demand fundamentals appearing strong, the transaction frenzy in the gold industry looks to be far from over.