Deals Are Starting To Happen In The Gold Mining Sector

Strengths

• Gold traders are split over the prospects for gold after prices recovered from an 11-week low reached on June 5. Shanghai Gold Exchange withdrawals reached 1,015.4 million tons as of June 5 and are on track to exceed last year’s withdrawals.
• The U.S. dollar slid after a French official said President Barack Obama told delegates at the G7 summit on Sunday that the strong dollar posed a problem. The dollar then pared its declines after the White House denied the statement. Omar Esiner, chief market analyst at Commonwealth Foreign Exchange, stated that there is a sense that both monetary- and policy-makers may be starting to become uncomfortable with the dollar’s strength.
• The gold monetization scheme in India aims to unlock the value of jewelry sitting idle. However, the current plan may not be enough to lure people to park their gold in a scheme that offers one gram for every 100 in a year. Furthermore, it may prove difficult to overcome people’s sentimental attachment to their jewelry assets placed on deposit as they will be melted for only a 1-percent return.

Weaknesses

• Assets in the world’s biggest gold-backed exchange-traded product slumped to the lowest since the start of the financial crisis as equities rallied and investors prepared for the onset of higher U.S. interest rates, hurting demand. Federal fund futures contracts are showing about a 58-percent probability that the Federal Reserve will raise rates by the end of the year.

• Global coin demand this year will probably slump to the lowest since 2008, according to TD Securities.  Some bloggers are using this and the gold ETF liquidations to support their disposition that gold should be avoided at this time.  However, as the chart above shows, we are now approaching some of the longest timeframes without a 10 percent correction in the S&P 500 Index.  As we outlined last week in our Investor Alert, the Fed is intent on ending its free money policy; Net Free Credit is at an extremely low reading; long rates have spiked, wiping billions out of fixed income market—what else might go wrong?  A correction in the stock market is inevitable, as the data shows.  Practice safe asset allocation; own some assets that don’t correlate to market returns, such as gold and or gold stocks, so you have a diversified portfolio to manage market volatility.
• The latest quarterly update of exploration spending from the Australian Bureau of Statistics shows spending on mineral exploration in the country hit a fresh, near-decade low.

Opportunities

• Deals are starting to happen and we believe that this will set the stage for further consolidation and rationalization in the gold mining sector.  Newmont Mining agreed to buy the Cripple Creek & Victor mine in Colorado from AngloGold Ashanti for $820 million. We see the price paid to acquire the asset giving most of the value accretion over to AngloGold.  
• A second consolidation announced this week will likely deliver some real value creation in the future.  Five junior companies came together to form one entity that will be worth an estimated $122 million. Collectively they have four projects holding more than six million ounces of high grade gold, along with $65 million in cash.  The deal was triggered by a $20 million investment by Osisko Gold Royalties into Oban Mining, which is leading the consolidation. Two of the juniors, struggling to advance existing projects, are to join forces with three that have significant cash piles but little in the way of exploration assets. The projects are located in Quebec and Ontario. John Burzynski, co-founder of Osisko Mining, will be the new CEO and Sean Roosen and Ned Goodman will be co-chairmen. In other news in the junior space, Eastmain Resources announced it has filed an independent National Instrument 43-101 technical report on its Clearwater gold project, which hosts 885,000 ounces of gold at a grade of 4.05 grams per tonne (g/t). For an open pit mining operation, this would be one of the highest-grade projects available in North America of significant merit. In addition, Balmoral Resources reported its final winter drill results at Bug Lake that included intercepts of 4.16 g/t gold over 38.19 meters, including a high-grade core of 25.05 g/t gold over 5.10 meters and 17.71 g/t gold over 9.00 meters.
• A new research report by analyst Simona Gambarini of Capital Economics suggests official sector buying can take much of the credit for establishing something of a floor for gold this year. Central banks have upped their share of overall gold demand from around 2 percent in 2010 to as much as 14 percent last year. Gambarini expects this trend to strengthen, thereby pushing up the gold price. Capital Economics has a year-end gold forecast of $1,400 per ounce.

Threats

• The $6 billion Resolution Copper Project in Arizona was discovered almost two decades ago and is slated to become North America’s largest copper mine. However, don’t expect production to start anytime soon due to the length of time it takes to get permits. Co-owners Rio Tinto and BHP Billiton waited 10 years to get federal approval in December to gain access to the land. It will likely take another five years to get permits from various federal, state and local agencies. The tortuous bureaucratic process to approve new mining projects in the U.S. is among the slowest in the world.
• Metals Focus took a look at the 10 major gold producers as a peer group to analyze performance and concluded that while costs have improved, the effective “shareholder margin” was very slim. As such, it is hardly surprising that companies have cut or even suspended shareholder dividends.
• South African gold producers and unions will start wage negotiations on June 22. Workers are asking for an 80-percent wage increase ahead of negotiations. The elected general secretary of the National Union of Mineworkers commented that “we think it’s highly affordable.” 

********

Frank Holmes
CEO and Chief Investment Officer
U.S. Global Investors