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General Market Commentary
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General Precious Metals
Miners Ride a New Wave of Consolidation
Investment Thesis: We believe a new gold mining mergers and acquisitions (M&A) cycle has been ignited, and we expect this merger boom to accelerate over the next several years. The tepid gold price environment since 2011 has forced many gold producers to decrease their focus on exploration and this has caused a significant drop in new discoveries, at a time when global gold reserves are being depleted (see Figure 1).
The challenging environment is forcing miners to strategically combine to reduce expenses and improve their operations. We expect these mergers will create a cascading effect in the industry as the combined entities shed non-core assets and prompt other companies to rethink their strategic priorities. Within the sector, we also see meaningful gradations of valuation between larger- and small-cap companies which could further fuel the cycle.
Our new investment strategy, Sprott Hathaway Special Situations Strategy, pays attention to many likely takeover targets and we believe it has the potential to produce positive returns even in the absence of rising gold prices.
Figure 1: Gold Production is Declining (2015-2025e)
Source: BMO Capital Markets.
Maria Smirnova: Whitney, you have been an active investor for several decades. When did you first become interested in gold and gold equities as a generalist value investor?
Whitney George: I have been in the investment business for nearly 40 years. I began my career as a retail securities broker in November 1980, just when Ronald Reagan was elected. At that time, investors were very interested in natural resources investments especially energy and gold. Investors were falling in love with gold mining stocks and the gold price was peaking. In 1980, gold prices had climbed to $850 an ounce (1/21/80), having risen from $37 at the end of 1970. I started off buying shares of gold mining companies like Homestake Mining Company, which at that time was one of the largest mining businesses in the U.S. and its oldest having opened in 1876 (it was later bought by Barrick Gold in 2001).
Unfortunately, as you can see in Figure 2, between December 1980, when I entered the business, and June 1982, the price of gold dropped in half from $635 to $300 an ounce. So my first experience with gold and gold equities was losing my clients money. This was difficult to swallow early in my career. Buying gold at a peak moment, and then watching it fall and erode my first clients’ assets, was an experience I did not get over quickly. I avoided gold and gold mining equities for another 20 years. During those two decades, the price of gold was range bound between $300 and $400.
Figure 2: Gold Price History (USD, 1970 – 3/31/2019)
Source. Bloomberg.
Maria: When did you take another look at gold and gold equities?
Whitney: I next revisited the mining industry in the late 1990s, when gold was about $300. As a value investor and generalist, and given my first experience with gold, mining stocks were not an area I looked at often.
I was also a dedicated Warren Buffett fan, and Buffett has never been positive about investing in gold. What encouraged me to take another look at the sector, was a seminal meeting I had in 1999 with a mining company executive, Bobby Godsell of AngloGold1. At the time, South Africa was the world’s largest gold producer, followed by the U.S., Australia, China and Canada.
Godsell described his strategy at AngloGold in very general business terms that made sense to me.
Maria: What was unique about AngloGold in the late 1990s?
Whitney: As a pure industrial idea, AngloGold piqued my interest. AngloGold was founded in June 1998 under Godsell’s leadership, and it represented the consolidation of the many fractional South African gold interests of Anglo American. Godsell helped identify AngloGold’s highest quality mines to keep, and identified others to dispose of or to sell back to the South African government for black empowerment initiatives.
Godsell described AngloGold’s mines as “factories.” He looked at each mine in terms of its returns-on-invested capital, and he was very focused on low-cost production. AngloGold’s stock was trading at 6 times earnings with a 6% dividend yield. The company was growing more profitable even as gold prices fell. South Africa’s currency, the Rand, was dropping even faster than gold, and both helped AngloGold’s mining costs decline steadily.
I did identify other promising South African mining companies like Goldfields, but I was nervous given the complications associated with Apartheid (which did not end until 1994), and so I started looking elsewhere.
Maria: Did you invest outside of South Africa?
Whitney: I found Canadian company Goldcorp, which was being run by Rob McEwen. Goldcorp was running its Red Lake Mine, one of the largest gold mines in Canada and the world (located in northwestern Ontario) and it contained some of the world’s richest grade gold ore. At the time, Goldcorp was producing gold for $75 an ounce, when gold was valued at about $300, and it was a well-run, very profitable business.
Maria: Do you tend to evaluate mining companies through a different lens?
Whitney: I have learned over my career that all businesses are cyclical. Most investors view a company as a “growth” business if it has been growing for a long time, and progressed without any disruptions. But it doesn’t matter whether you are evaluating a technology or a finance company, for example, all businesses have their cycles.
For mining companies, business cycles can be very long. It takes many years to find ore deposits and then turn them into productive mines. As shown in Figure 3, the discovery-to-production period has gotten much longer. For the mining industry, its business cycles can span 2-3 generations, and play out over decades. To invest in this sector takes commitment, patience and understanding.
Figure 3: Years Between Discovery and Production is Increasing
Source: SNL Metals & Mining. U.S. Global Investors IAMGOLD.
Maria: Gold declined in the late 1990s bottoming at $250/ounce in 1999. Can you discuss the wave of consolidation in the gold mining industry at the time?
Whitney: In the 1990s, the mining industry was struggling and there were too many companies running single mines. This triggered a wave of consolidations, rollups, and acquisitions that lasted into the early 2000s. Kinross Gold was a notable example. Founded in 1993 by Robert Buchan, Kinross represented the amalgamation of three companies: Plexus Resources Corporation, CMP Resources and 1021105 Ontario Corp. Another example was Newmont Mining.
After gold fell below $400 an ounce in 1996, Newmont began aggressively snatching up smaller U.S. domestic miners and slashing costs. This all culminated in the large 2001 acquisition of Normandy Mining, Australia’s largest gold producer, and Canadian Franco-Nevada Mining. This vaulted Newmont to the top spot in gold reserves and production, ahead of its rival AngloGold. Newmont, AngloGold, and Barrick represented the top three gold miners at that time (2002).
This wave of consolidations helped mining managements gain much-needed cost efficiencies, which is a healthy business practice when you are in a difficult part of the business cycle. Because they had improved the quality of their businesses, when gold prices began to rise in the 2000s, these mining companies became very profitable.
Maria: Do you see similarities between today’s M&A activity and the previous period in the 1990s?