Last week, I pointed out that the major gold miners have a serious problem.
They’re running out of gold.
Here is a quick rundown of what’s going on.
- Following painful cutbacks over the last several years, development and exploration spending was cut to the bone.
- New production takes years or decades to come to fruition, creating a tenuous and greatly delayed link between prices and supply.
- Right now, while gold is steadily rising, we’re looking at gold supply to start dropping in 2017 and 2018.
- Combine all of this, and the major miners have seen their reserves drop by one-third, from a peak of 27 years of production to 18.
- Therefore, to combat the rapid depletion of their sole product, major miners will have to fork out billions over the next several years to acquire junior miners with the best projects.
Unfortunately for the major gold miners, that isn’t the only thing going wrong for them. And boy did they get called out.
Shooting Themselves In The Foot
Last week, we saw a rare thing: A reliable and longtime gold bull issuing a call to arms against gold miners.
Marcelo Kim, a partner at Paulson & Co. — led by John Paulson of obvious fame — stepped up to speak at the Denver Gold Forum, the industry’s biggest annual event.
What came next was a brutal takedown of the biggest names in the industry, followed by a call for fellow founding members to join Paulson & Co. to speak out on issues that are creating serious problems and causing share prices to underperform.
The focus of this “Shareholder’s Gold Council” would be to issue recommendations to shareholders regarding votes on company takeovers and chief executive officer pay.
Another major firm, Tocqueville Asset Management LP, is already on board and Vanguard Group, BlackRock, State Street, and Van Eck Associates were mentioned in the presentation as well, undoubtedly drawing their attention.
Among what Mr. Kim cited as problems were high executive pay, cozy board appointments, and value-destroying mergers and acquisitions.
In his own words, “If we don’t do anything to change, then as investors we will continually be disappointed with shareholder returns and the industry will slowly dig itself into a hole of irrelevance and oblivion.”
The numbers he used to drive home his points were damning:
Average total shareholder returns from gold mining investments are at -65% since 2010 over a period when gold prices rose by 20% and the price of oil (a major cost for the miners) fell by 28%.
Over the same period, the CEOs of 13 of the largest gold miners have received a combined $550 million in compensation.
A Dose of Reality
This is a dose of reality that the C-suite crowd at the major gold miners have to deal with.
The narrative has been about recovery, improved debt outlook, and cost reductions over the last couple years, but there is still a host of problems the major miners have to face.
What I talked about last week is part of that list. Gold miners have to buy projects at an accelerating rate to maintain the long-term viability of their companies.
The alternative is to keep mining themselves out of business, and have company valuations tank over reserve concerns.
But Mr. Kim is right to add value-destroying mergers and acquisitions to that list as well.
As he pointed out, the industry has written off $85 billion since 2010 due to overpaying for acquisitions and large cost overruns constructing mines.
There is no real conflict between these two ideas, though there could appear to be one on the surface.
Yes, they need to spend a lot more on acquisitions. Yes, they need to do a whole lot better at acquisitions. They aren’t mutually exclusive.
The realities of reserves depletion are real, and an existential threat if allowed to continue, and it is far too late to start new exploration and development to stem the tide.
The prospect of major shareholders focusing on overpaying for assets will have a big effect throughout the industry if Paulson & Co. gets what it wants.
Competition Will Heat Up
We’re already seeing a lot of M&A activity, along with individual asset sales and purchases. Much of this is happening between junior miners and mid-tier companies.
About $2.2 billion of M&A deals were struck in the gold sector during the second quarter of this year.
This is the start of a scramble to reposition asset portfolios among smaller companies to build ideal packages for joint ventures and outright sales to the majors.
The companies with the strongest assets, and the best management teams for securing those assets at favorable prices and with favorable terms, are going to continue to command hefty premiums from the major miners when the time comes.
Those that do not do as well will face the fate most companies with too much debt, too much cheap paper floating around the market, and too few results always do. They’ll collapse, and their assets will be divvied up in fire sales.
While Mr. Kim and Paulson & Co.’s call to arms is a big warning sign for the majors that they need to get their houses in order, it also serves another function.
It points out that while mergers and acquisitions have to happen, a rising tide need not lift all ships. The value of junior miners will spread out dramatically between the best and worst.
It is a fantastic time to own junior miners that are going to partner with, or be bought by, the major companies.
Just make sure that you follow the latest research and analysis and only hold the ones worthy of commanding a premium.
