Oh to be a gold bug in this handbasket ride into hell
Miners are getting ready, for at some point the market is going to realise that gold is rare stuff and getting rarer
I have always loved chatting to people in the gold industry. Most people in the investment industry and all the associated professions, not to mention investors themselves, are banking on their investments going up. They are structural optimists.
But if you ever want a reality check, people in the gold industry are where you go. For them, everything, but everything, is going to hell in a handbasket. Everything – except of course for the gold industry which is just on the verge of a massive turnaround.
Gold is, in some ways, the alternative to all other investments rather than being an adjunct to them. Gold, and by extension gold mining, is a notional haven amid a sea of excessive enthusiasm. Gold bugs are, by nature, cynics about everything other than the thing they should probably be most cynical about: gold.
While it’s fun to chat to gold bugs, I have always secretly thought investing in gold companies is a bit of a mug’s game. It’s possibly the result of being a South African of a certain age; the previous generation lived through the massive gold boom in SA when gold mines were popping up all over the country, and SA was eventually producing 75% of the world’s supply. The gold mines absorbed labour, were prosperous, underpinned the economy, and provided a fiscal hedge for government. Golden days, if you will.
But since the 1960s and 1970s, it’s been all downhill, as miners were forced to dive deeper and deeper into the earth, which became gradually more expensive. In 1994, SA produced about 30% of the world’s gold; it now produces less than 5%. Two-thirds of SA’s gold mines are running at a loss. It’s been a depressing sight.
Having seen this decline, I find the two huge gold industry mergers in the past few months really interesting. The fact is that the problems faced over the past few decades by the SA industry are now international problems. Ironically, that might be a good thing for investors.
Just take a closer look at the latest mega-merger. Newmont Mining has offered to buy another Canadian gold producer, Goldcorp, for $10bn. The important thing is that this is an all-stock deal between two companies that have circled each other for years but have repeatedly said there is no point getting bigger just for the sake of it. Now the press release emphasises that the company will be the world’s largest gold miner. To me, an all-stock deal highlighting the size of the new company in the industry suggests companies trying to get bigger for the sake of it.
The reason they would do so primarily revolves around valuations because gold mergers seldom result in greater efficiencies or higher production unless the gold mines in question are adjacent. One analyst rather rudely entitled his market report on the Newmont merger, “Two overvalued companies become one overvalued company.” The directors themselves are by no means over-promising on the synergy front, promising pretax synergies of $100m. After tax, this would constitute just 0.2% of the enterprise value of the combined companies.
At least some analysts think the merger will be dilutive rather than accretive, meaning the merger will result in lower earnings per share for Newmont shareholders. This is visible if you compare the inflated price-to-earnings ratios of both companies; Goldcorp was trading on a 33 p:e prior to the deal and Newmont on a 25 p:e. Join those two together, and add a 17% premium for Goldcorp shareholders, and it is very hard to see the industrial logic in the merger.
So why are they doing it? The simple answer is that finding gold that is cheap to mine is very difficult, not just in SA but around the world. The depletion of high-grade gold reserves, particularly in stable jurisdictions, is forcing miners to look at other options, mergers being one of them. Until recently, arguably the most effective gold miner was Nevada-based Barrick, but its production has dropped more than 25% since 2013, to 5.3 million ounces at the end of 2017.
The stock market has not been fooled for an instant. The Goldcorp share price barely moved on the news, despite the fact that the exchange ratio suggested a 17% premium to the share price. Newmont got thumped and is down about 4% on the news. Compare that to the Barrick/Randgold deal which saw Barrick’s price rise 6% at one point before sliding back more recently.
This may be good news, at least in the medium term, for the gold industry because at some point the market is going to realise that gold is rare stuff and getting rarer. If all the gold ever mined were made into a single block, it would fit into an Olympic swimming pool.
While US interest rates are rising, the gold price will be under pressure because the “haven” money out there will tend towards investments that earn some kind of return. But at some point that will end, and gold will regain its lustre.