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Junior Gold Stocks : My Pot Of Gold - by Aaron Hoddinott
As an investor who holds positions in junior gold stocks, I can’t help but get excited after reviewing the latest financial results from some of the majors. The major gold producers are starting to show the profits that come with historically high gold prices. The Q4 results from some of the majors signaled what will likely be a long-term merger and acquisition period amongst gold miners.
Kinross Gold (KGC:NYSE), Barrick Gold (ABX:NYSE) and Newmont (NMC:TSX) all showed great profits in the final quarter of the year, representing the high gold prices in the last half of 2009.
Kinross reported a profit for the fourth quarter compared to a loss in the same period a year-ago. Earnings per share for the quarter more than doubled and topped analysts' consensus estimate. Revenue for the quarter surged 44%.
Barrick Gold’s profit margins rose to $645 an ounce from $338 a year earlier. Barrick earned $215 million, or 21 cents a share in the fourth quarter, compared with a loss of $468 million or 53 cents a share a year earlier. Barrick booked a record adjusted profit of $604 million, or 61 cents a share, up from $277 million, or 32 cents a share a year earlier.
Newmont Q4 profits skyrocketed as well. The company earned $558 million, or $1.13 per share, compared with $4 million, or a penny a share, during the same period last year.
Long story short, the majors’ pockets are getting fatter and will continue to swell for a very long time. Just imagine what kind of profits the ‘big boys’ will turn out when they have the next 2 to 3 years to sell their bullion for more than $1100 per ounce. Remember, last year gold prices averaged around $950 an ounce; those days are behind us and the average gold price is going to be much higher. For every $100 increase in bullion prices, companies such as Barrick, which produces nearly 8 million ounces per year, will potentially increase their profit margin by nearly $800 million annually. They can scoop up a lot of great junior gold miners for that extra chunk of change- and I fully expect them to do just that.
With the global output for gold declining by nearly 1 million ounces per year since the early 2000’s, producers have been nervously searching for their next acquisition. This is one of the most competitive industries in the commodity sector. The majors are in a race to scoop up as many quality assets as they can find before their competition beats them to the punch.
With a lack of quality assets available in the gold sector, majors will be forced to either pay hefty premiums for the giant deposits (2 million ounce plus) or take on more of a role in exploration and FIND the next giant deposit. I don’t see them doing the latter unless through a joint venture which will almost inevitably lead to a buyout for the other company involved (provided the asset is economic). Majors know production, historically, they have failed miserably in prospecting and exploring(I can’t count how many great deposits I know of which were abandoned by majors in the past and now owned by junior explorers who are proving them up to be world class deposits). This opens the door for the explorers to be bought out.
There is still a major valuation disconnect between explorers and producers. Explorers as a whole are still very cheap. Majors, however, are not. Their true value, I believe, has been priced in. Of course that will change as the price of gold rises, but juniors are cheap even with today’s gold prices. Heck, a lot of them would still be cheap if gold was $850 an ounce.
So how do you find a potential buyout candidate in the gold exploration sector?
Here’s some loose guidelines of what I look for:
1.) A company whose asset (sole ownership) has a resource calculation of at least 300,000 ounces with significant exploration upside i.e. open at depth and in either direction (N or S - E or W). Average grade of at least 2g/t. If the company has near 300,000 ounces proven, they better have less than 60 million shares outstanding because future financings are inevitable and dilution is one of the main concerns when investing in junior explorers.
2.) A company that owns an advanced exploration gold deposit within 20 miles of a producing mine owned by any of the majors.
3.) If the company has a JV with a major, they must have at least $1 million in the bank in order to cover expenses. This is crucial as some JV partnerships with majors require the junior to raise significant amounts of cash on an annual basis to meet work obligations. For a major to finance its share of an exploration project it requires very little effort on their end as they are highly solvent - juniors rarely have that luxury and if they don’t meet their financial obligation, they can be squeezed out of the deal ( a tactic that has been used by majors in the past). So be sure to understand the financial commitment required by the junior involved in a JV with a major. If the junior is constantly operating on a shoe string budget, you know dilution will be constant and dangerous for shareholders. There is nothing worse than being a shareholder in a company that has to constantly raise capital and do so with the clock ticking. Before you know it that company will be diluted to the roof and be worth a fraction of what you paid for it.
4.) Infrastructure is a must. Roads, water, electricity and a local workforce. These are the bear necessities of a gold asset. Without at least roads, water and electricity, the capital cost to ever go into production will be astounding.
5.) Based in North America: With China as the number 1 gold producer in the world and Australia reclaiming its number 2 spot from the US, competition is heating up. The US and the rest of North America is loaded with great gold assets that will be brought into production soon enough. Gold is the ultimate store of wealth and with China as number 1, the US is going to exploit its homegrown assets. Canada will do the same. I feel this will be the hotbed for mergers and acquisitions in the gold sector for the better part of the next decade. I want to own explorers on this continent.
6.) A company whose management has been involved in buyouts in the past. A management team which has brought a deposit to a buyout stage in the past can do it again. They have the necessary intelligence, experience and connections to make it happen.
7.) A company whose insiders own at least 10% of the outstanding shares. If they don’t own it, they don’t believe in it...And neither should you.
There is a limited amount of gold left in the ground. High quality assets are becoming harder and harder to find. Over the past 100 years we have mined 130,000 metric tons and there is an estimated 90,000 metric tones of gold left to be mined in the world. These facts are straight from the USGS report (US Geological Survey).
According to a Reuters report released over a year ago ( the situation has gotten worse since this report) “A shortage of high-quality mines and exploration projects is keeping a lid on mergers and acquisitions in the gold mining sector, the head of Randgold Resources (RRS.L) said on Tuesday.
"We don't have enough quality assets and I think that is what is stunting M&A," Randgold CEO Mark Bristow said in an interview with Reuters after a presentation to the annual Indaba African mining conference in Cape Town.
"There isn't a lot out there," Bristow said.
Have a great week,
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Long Positions: Kinross, Barrick
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May the Irish hills caress you
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May the blessings of St. Patrick behold you.
Aaron Hoddinott is not an investment advisor and any reference to specific securities in the list referred to in the article does not constitute a recommendation thereof. The opinions expressed herein are the express personal opinions of Aaron Hoddinott. Nothing in this article should be construed as a solicitation to buy or sell any securities referred to in the list or in the article. The author bears no liability for losses and/or damages arising from the use of this article.