Why gold bulls are too timid for takeovers


By David Berman
The Globe and Mail, Toronto
Thursday, September 27, 2012


Here's an open challenge to the world's gold producers: Start snapping up your rivals.

After all, gold is going higher, isn't it? Commerzbank AG believes it will hit $2,000 (U.S.) an ounce next year due to ongoing economic risks. And Bank of America believes it will rise to $2,400 an ounce by the end of 2014, thanks to ongoing economic stimulus efforts by the U.S. Federal Reserve Board.

Even gold executives, by nature usually conservative on gold prices, believe it will top $2,000 an ounce by this time next year, according to Bloomberg News.

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If they're right, gold's winning streak will extend to 14 straight years. Its price has risen from a mere $272 an ounce at the end of 2000 to more than $1,750 today, for a total gain of about 550 per cent.

If the stuff you are mining is rising impressively each and every year -- and you are confident that the underlying fundamentals will drive it still higher -- it only makes sense to produce as much of it as you can, either by finding more or buying rival producers.

Gold executives talk a good game.

The chief executive of Nordgold told the Financial Times in April that a wave of mergers and acquisitions "should be inevitable" because of low valuations.

Goldcorp Inc.'s chief executive told Bloomberg News much the same thing this month.

"The development-company valuations have come down to where, at least on paper, it looks like there's some opportunities," Chuck Jeannes said. "There's a lot of looking going on."

So far this year, the looking hasn't exactly progressed into a torrent of deals.

According to Mergermarket, which tracks mergers and acquisitions globally, the total value of gold deals announced in 2012 is just $8.3-billion, as of September.

That puts deal-making within the gold sector on track to its lowest level since 2004. And it pales next to the $37.3-billion worth of deals in 2011 and $29.3-billion in 2010, when gold traded about $500 below its current level.

For sure, companies look like tempting takeover targets. For gold companies in the NYSE Arca Gold Bugs index, the average price-to-book ratio -- a key metric of a company's valuation by the market -- is now just 1.8, versus an average of 2.5 over the past decade.

So with deals to be had, why has the deal-making slowed so much?

It's hard to ignore the fact that the share prices of gold producers haven't been keeping up with the price of gold.

Over the past decade, the Gold Bugs index has lagged the price of gold by an astounding 130 percentage points.

Blame the underperformance of gold producers on high operating costs, widespread labour disputes and the popularity of bullion exchange-traded funds as the most likely destination for gold-seeking investors.

Either way, the lagging share prices have robbed companies of an important takeover currency, and they have made acquisitions look less rewarding than funnelling excess cash to shareholders in the form of bigger dividends.

Besides, some acquisitions have gone so badly that it wouldn't be surprising to learn that many chief executives are now downright scared of splashing out.

In 2010, Kinross Gold Corp. (full disclosure: I own this stock) bought Red Back Mining Inc. for $7.1-billion, only to write down the asset by $2.9-billion earlier this year after Kinross's share price had cratered.

Tye Burt lost his job as Kinross' chief executive this summer -- and the Red Back deal is seen as the most likely reason behind his abrupt departure.

Still, you would think that confidence in a rising gold price would override these concerns. Deal-making might be just the thing to draw investors back to the gold mining sector, providing a signal that executives stand behind their gold-price forecasts.

It is one thing for gold bugs -- whose enthusiasm never wavers -- to claim that gold has nowhere to go but up. But bullish enthusiasm from mining executives is another matter entirely. And they've gone awfully quiet.

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