Special report: Are the days of "big gold" over?

As cash pressures mount, gold majors move to mine the markets, which are proving more lucrative than the mining of gold.

JOHANNESBURG - - 

Two of the world's biggest three gold miners, Barrick and AngloGold Ashanti, have started moves - no matter how tentative - towards possible constructive disintegration, as pressures continue to mount on gold miners world wide, despite eight successive years of rising dollar gold bullion prices.

For well over a decade, gold miners have indulged in heavy merger and acquisition activity, but now, Big Gold may be on the last legs of a ride it never really paid for in the first place.

AngloGold Ashanti has indicated that it may split its global portfolio, following last month's news that Barrick, No 1 in global gold mining, would be floating off 25% of, and listing, African Barrick Gold, in London, within the next few weeks or so. To this overall story there are at least two legs, one thin and gaunt, the other heavy and twisted.

But before a trip below the belt for a more detailed account of the Two Legs, consider that big gold diggers may have become too big, at least in the sense of too many operations that don't make the Tier I grade. Overall, gold companies increasingly battle to find "replacement ounces" for ones that are mined daily out of the ground. Investors have long pressurised the "grow ounces" theme, which for now seems to have run out of steam, both on the production and acquisitions front.

There is also the sheer enormity of centrally managing mine after mine after mine. Barrick operates 26 of them, and has three capital-gobbling projects in construction.

Newmont, the No 2 gold miner in terms of production, also manages mines all over, yet well over half of its turnover can be traced to its Nevada mines, and its 51% stake in Yanacocha, Peru. While Australia's Boddington will rise in importance as it ramps up to full production, Newmont, which has been around for decades, would probably do itself little harm by refocusing.

Newmont's stock price is not alone among gold miners in sending out some kind of a message; leaving aside a merger and acquisition spike in 1987, Newmont's stock price first made record highs around USD 60.00 a share early in 2006, and is yet to get back there. It has been as low as USD 25.00 since, and is currently trading around double that level. AngloGold Ashanti operates 21 mines on four continents, ranging from ultra deep level mines in South Africa to mines of all kinds elsewhere in Africa, Australia, the Americas, and beyond.

LEG ONE: THIN AND GAUNT

Leg One - the ailing one - for gold miners is mounting evidence that mining the yellow metal is less lucrative than apparently so clearly perceived by the vast majority of investors who slavishly support the sector. Most of the major gold miners have reported for 2009; nine of them - Yamana, Harmony, Lihir, AngloGold Ashanti, Barrick, Newcrest, Gold Fields, Kinross, and Newmont - produced an aggregate USD 10.9bn in operating cash flow for 2009.

While that was well higher than preceding years (in line with record dollar gold prices), after financing USD 8.5bn in capital expenditure, just USD 2.5bn was left in the form of free cash flows for 2009. Of that, in turn, nearly USD 1bn was then paid out by way of cash dividends.

A good chunk of these thin "gold" free cash flows can be traced to sales of other metals, mainly copper, produced by gold miners. The superior margins offered by copper produced wonderful cash flow as 2009 pressed on, and cash is what gold miners need more than ever.

While gold companies could well be expected to be floating in cash after eight successive years of rising dollar gold bullion prices, on the contrary, the nine gold miners mentioned raised, by way of rights issues across the three years 2007 to 2009, no less than USD 13.8bn in cash. "Patient" may be a kind word for the investors who continue to plod painfully behind the big gold miners, supporting them with billions and billions of dollars in cash.

"They flood the market, so it takes a long time for it to digest the increase in shares" - John Ing, president of Toronto investment dealer Maison Placements.

Good chunks of the USD 13.8bn in cash raised across three years were directed to attacking hedge books, taken out in years gone by when gold miners bet that the gold prices would fall or churn sideways, rather than increase. In late 2009, Barrick ploughed USD 5.2bn of cash into all but destroying its hedge book. Equity investors who bet on gold miners who believed gold prices would no nothing, at best, have apparently been happy - at least in the cheesy sense - to bail out those toxic hedge books.

Further evidence of gold company cash paucity was that the nine gold groups ended 2009 with an aggregate of USD 7.2bn in net debt, including cash. Apart from a billion dollars of cash pushed out in the form of dividends during 2009, cash is flying out of gold companies in many directions. Challenged by years of promises made to investors, gold companies are pulling out more stops than may now be available.

There is a growing sense that renewed equity calls on investors may be met with sour faces, aggravated by the relatively sound beating that gold stock prices have taken since early December 2009, when gold bullion made nominal records above USD 1,200.00 an ounce.

Faced with heavy capital expenditure programmes going forward - Barrick is spending USD 3bn at Pascua Lama alone - gold miners have been pushed into finding alternative ways of raising cash. This all moves the story to the heavy and twisted Leg Two.

LEG TWO: HEAVY AND TWISTED

Leg Two is all about the strange and persistent over-pricing of listed gold stocks. Relative to other mining stocks, and indeed, any other kind of stock, gold miners have long been overvalued, trading at a "premium", supported on the one hand by hordes of incurable gold bullion evangelists, and on the other, by sell-side investment analysts in New York, London, Toronto, Sydney, and beyond. Collectively, this pool contains a high percentage of the world's most egocentric eccentrics.

Both tribes are addicted to the idea that there is one commodity that for every known and unknown reason should just keep rising in a straight line, into eternity. Gold company executives are stuck awkwardly between the two tribes, marketing pearls of wisdom to keep the frothing savages at bay.

It seems that for years now no gold company executive has ever anticipated anything other than ever-rising gold bullion prices, while the companies at hand just continue to magically "increase ounces". Accounting devices deployed by gold companies have become increasingly imaginative, inevitably all aimed at presenting cases that continue to magnify departures from realities. Far away on the horizon, bubbles of hellfroth are starting to gather.

Executives of any listed company are gatekeepers, intent on producing goods and/or services that generate high-margin cash flows, thrashing the competition, and keeping stakeholders happy, be it employees, shareholders, bankers, or bureaucrats. Keep the chickens happy and they will keep laying golden eggs; protect them from foxes and the flock will expand.

But times change and here, the gatekeepers of gold companies have steadily lost the plot as cash-generating authority has moved inexorably away from gold production. The chickens, still laying gold eggs, but smaller ones, and with less frequency, are screeching to be released. It's as if they want to be eaten, and quickly.

Gold mining may be painfully difficult, but investors remain ever-keen to tempt the foxes. There is big cash out there for gold diggers, but not in the ground. Monetizing gold assets listed on stock exchanges yields astronomically more cash than gold mining.

A prime case was seen when in March 2009, Anglo American, a big diversified miner, sold its remaining tranche of stock held in AngloGold Ashanti to Paulson & Co, a US hedge fund. That sale, of 11.3% of the stock in AngloGold Ashanti, raised USD 1.28bn in hard cash for Anglo American. A pile of cash that big is cool.

AngloGold Ashanti paid cash dividends of USD 56m in 2009.  Had Anglo American retained (rather than selling) its 11.3% stake, it would have received USD 6.3m in cash dividends during 2009. At that rate, leaving interest on cash aside, it would have taken more than a century before cash dividends received and accumulated vaguely approached the USD 1.28bn cash raised by selling out the 11.3% stake in AngloGold Ashanti.

After Anglo American quit the gold scene, none of the world's major mining companies can be said to be taking gold mining seriously. For years and years, the evidence has piled up showing that while gold mines may look pretty in a portfolio, if cash generation is the objective, sell, and run like hell; as in one firm of lawyers that probably never existed was named, Sue, Grabbit & Run.

GOLD LOSES ITS CASH-GENERATING MOJO

Over the past 10 years, cash-generating authority among raw materials producers has moved towards commodities and metals in which China is, or has become, a decisive net importer. That happened about six years ago in seaborne iron ore. BHP Billiton, one of the three dominant players in that game, recorded iron ore revenues of USD 9.5bn in the fiscal year to 31 June 2008, and operating profits for its iron ore segment of USD 4.6bn, providing, on this basis, a margin of close to 50%.

Try this from the news wires this week: "China has changed the playing field in the iron ore sector, sucking in seaborne supplies like a giant vacuum to fuel an economy that will produce more steel in the 15 years from the turn of the century than was manufactured by the entire world from 1860 to 2000, according to an executive of a London-based consultancy".

As Chinese growth continues, the wider ferrous theme increasingly maintains cash-authority momentum, be it for iron ore, or its bedfellows, such as manganese, molybdenum, ferrochrome, nickel, or coking coal. These commodities have distinct utility value, unlike gold, where demand, at least in the West, relies on a weird and jangled cocktail of human vanity and doomsday sentiment.

Cash generation is, as ever, about keeping unit costs low and pared, and moving massive volumes of units. Many of the ferrous commodities are produced at big, if not massive, scaleable operations where mining is only as important as logistics, spanning the entire family of transport links, from handling to rail to port handling to shipping. While post-production logistics is only a tiny part of gold production costs, many gold operations lack operational economies of scale and are highly vulnerable to cost pressures.

The world's biggest gold mine, Freeport-McMoRan's Grasberg, produced 2.6m ounces of gold (being Freeport's 91% stake) in 2009, and 1.4bn pounds of copper. The mine's gold production, which may be regarded as a byproduct to copper, alone ranks Freeport as one of the world's top five gold producers. Unlike miners that rank gold as No 1 focus and interest, Freeport produces astounding cash flows, leaving any self-professed gold miner of any kind, anywhere, deeply in the shade.

Gold miners have benefited from a bullion price that moved from around USD 250.00 an ounce a decade ago to nearly USD 1,000.00 an ounce higher in December 2009. It has not been enough for gold miners. As to gold bullion's price outlook, various kinds of statistics available on China and gold appear to be really firm only on one issue: for the past few years, the country has ranked as the world's biggest miner of gold.

Twinned with gold's questionable status as a metal of utility, rising Chinese gold production is hardly upbeat for gold pricing. The drift of that story is that China's overall supply-demand status in global gold is unlikely to add any real impetus to gold making any notable headway up the ladder of cash-generating authority.

Barrick and AngloGold Ashanti seem to have no qualms in apparently discovering that mining markets for cash is likely to yield more cash than mining gold out of the ground. This notion makes sense, in the sense used by those entrepreneurs who believe that a good mining story should never be ruined by actually building a mine.

THE FOLLY OF CHASING "OUNCES"

For years, gold companies have juggled heavy duty single blade samurais with two razor-sharp edges. The overvaluation of gold stocks has meant that, given the longer run bull market in dollar gold bullion, equity can be raised from investors with relative ease. For gold companies, the curate's egg is that acquisition targets are inevitably overpriced. It seems that gold diggers have little trust for each other, expecting, in most cases, that hard cash be coughed up for takeovers.

Financing of cash takeovers has inevitably come by way of rights issues, with motley crews of equity investors across the world throwing cash, time and time again, at the "growing ounces" story. If this was not already a recipe for potential disaster, many of the gold assets being acquired have been recycled, sometimes so many times that nobody really seems to know just how many.

Followed through, the process can be likened to a hysterical hamster on a mill, a hamster that gobbled down a spill of narcotics accidentally left strewn around by its human owner. Happily, there are exceptions; ever-sober Canada-based Yamana can be noted as having just 2.3m issued shares back in 2003, before it set off on a life of chasing ounces, and making the big time.

Since then, Yamana has raised cash of USD 816m in fresh equity from its adoring investors. Besotted also with acquisitions, Yamana's issued shares have exploded to 734m; it carried net debt of USD 359m on 31 December 2009, and is yet to produce any notable free cash flow. In emphasising its climb up the proverbial ladder, Yamana has paid dividends for the past four years.

In another form of ingenuity not uncommon across the gold sector, Yamana produces "GEO", being "gold equivalent ounces", and defines itself as a "Canadian based gold producer engaged in gold mining and related activities", yet a forensic examination of its 2009 accounts indicates that about a third of its revenues for the year were attributable to . . . copper sales.

Without copper, Yamana would no doubt have ended up on the ropes. Copper is a big story for gold miners with feet in the metal; Barrick and Newmont rely increasingly on the diversification. They can only envy Freeport; China has for years been a decisive net importer of copper.

CHINESE INTERESTS INDIFFERENT TO GOLD PROJECTS, COMPANIES

If China is the epicenter of global economic activity, acquisitions and investments by country interests in foreign producers of raw materials is bound to continue for years to come. In the past few years, Chinese companies, inevitably with Chinese government backing, have invested billions of dollars in mining and energy projects and companies across the world.

In terms of size, the biggest capital raising mining transaction - which never materialised - would have been Rio Tinto's February 2009 proposed raising of USD 12.3bn from Chinalco by selling equity stakes in some of Rio Tinto's most prized aluminium, copper and iron ore assets.

Chinalco, an arm of the Chinese government, holds 38.6% of listed Chalco, and also 26.6% of listed Yunnan Copper. Rio Tinto also wanted to sell convertibles worth USD 7.2bn to Chinalco; that deal also croaked. These putative deals were about anything but gold, which is produced as byproduct at some of Rio Tinto's copper mines.

There have also been investments by Chinese sovereign entities, such as China Investment Corporation, which bought stock in Canada-based Teck for CAD 1.7bn in July 2009. Teck, which has peripheral interests in gold, and sold some gold assets in the past while, is global No 2 in coking coal, an essential product in reducing iron ore, and a significant player in copper and zinc.

What's the point? Well . . . that there's been little in the way of Chinese investment flows into gold projects or gold miners. On the contrary - and this is rare - foreign mining companies classified under the gold heading have been investing in Chinese mainland gold projects and companies; examples include Continental Minerals, with the Xietongmen deposit, discovered in 2005, and Eldorado, which in December 2009 completed its acquisition of Sino Gold, for the gold mines Jinfeng, White Mountain, and Eastern Dragon.

It's as if the Chinese are bemused by the West's obsession with gold. China's biggest listed gold miner, Zijin, has shown only lukewarm interest in foreign assets and, on all appearances, seems more interested in platinum, copper, and polymetallic miners, given Zijin's links with Monterrico, Ridge Mining (now within Aquarius), and the very little Pinnacle Mines.

THE RULES OF TIER I

Marius Kloppers, CEO of BHP Billiton, the world's biggest diversified resources entity, has, like his predecessors, often reminded that only Tier I assets will do. The problem, as such, is that Tier I assets rarely come onto the market, and, as such, acquisitions by BHP Billiton are unusual.

So far this decade, the biggest ranks as the USD 7.2bn cash take out of Australia's WMC in 2005, mainly for Olympic Dam, which ranks as the world's No 4 copper, No 1 uranium, and No 4 . . . gold, deposit. In September 2008, there was the largely unnoticed acquisition, where BHP Billiton invested USD 1bn, via the BHP Billiton Mitsubishi Alliance, in the New Saraji coking coal exploration project from Australia's New Hope.

BHP Billiton is also building up a Tier I asset, but from closer to grassroots, in potash. It is buying via a USD 320m cash bid into Athabasca Potash. BHP Billiton in May 2008 bought for USD 282m Anglo Potash, which held 25% of a Canadian joint venture company, in which BHP Billiton already held the other 75%. The Jensen project is adjacent to the Burr Project, now under acquisition from Athabasca Potash.

BHP Billiton, which holds a current market value of USD 206bn, one of the highest of any kind of stock in the world, has the firepower to pounce on most mining stocks.

As for Tier I gold assets, after the Witwatersrand, the world's biggest gold field, which has been mined by dozens of companies for well over a century, it may seem odd that most of the world's biggest gold deposits are either not in production, or not operated near optimum levels; stranger still, perhaps, that only a few self-confessed gold majors are involved.

After the Witwatersrand there is Muruntau (which also contains silver), State-owned and run; Grasberg (which runs at optimum levels, and is primarily copper, owned mainly by Freeport-McMoRan), Olympic Dam (developing, primarily copper and uranium, BHP Billiton), Pebble (undeveloped; copper, Northern Dynasty, and Anglo American), Natalka (Polyus), Sukhoi Log (Polyus, maybe), Oyu Tolgoi (undeveloped, copper, Ivanhoe Mines, and Rio Tinto), Reko Diq (undeveloped, copper, Barrick, 37.5%, and 37.5% copper major Antofagasta), and Lihir, which runs optimally.

Over the past decade, as gold companies spent billions of dollars on mergers and acquisitions, Tier I assets have remained elusive, both as to acquisition and as to development. Many of the assets that have been acquired, merged into, and even discovered, have yielded poor returns, as seen in today's relatively modest cash generating abilities of major gold producers.

CASH FLOW IS KING

If nine of the world's major gold mining companies, produced free cash flow of USD 2.5bn in 2009, which is indeed the case, one group, by name Freeport-McMoRan, produced USD 2.8bn in free cash flows. Freeport has no illusions about its business: "Consolidated sales for the year 2009 totaled 4.1 billion pounds of copper, 2.6 million ounces of gold and 58 million pounds of molybdenum". The group is No 2 globally in copper, No 1 in molybdenum, and No 5 in gold, after Barrick, Newmont, AngloGold Ashanti, and Gold Fields.

Freeport's group revenues for 2009 were USD 15bn, of which USD 2.7bn was attributable to gold sales. The kind of free cash flows that Freeport generated in 2009 were all the more remarkable, given that copper prices started the year at multi year lows. In 2007, when copper prices were more stable, Freeport generated free cash flows of USD 4.5bn, compared to the negative USD 2.6bn free cash flows generated by the nine major gold miners in 2007.

Freeport's story is simple, compared to the generally garbled messages coming from miners that promote gold as prime business. For Barrick and AngloGold, at least, it seems that the gold chicken has come home to roost, and that the time is ripe to mine the markets. Just what this will do for investor returns remains to be seen, but the foxes are looking at crashing into the gold investor's henhouse.

THE SPECTRE OF TERRIFIED BULLS

There's nothing sadder than a stale bull, and nothing more tragic than a gold bull that's lost its marbles and marsh mellows, and has red ink spattered all over. If dollar gold bullion prices make considerable gains going forward, which gold bugs across the earth and indeed across the universe insist will be the case, then pressure on gold miners to produce convincing cash flows will ease, for the meantime. For now, the hunt for cash intensifies.

Were it not a pushover in itself that markets can be easier to mine than holes in the ground, there is more. Certain markets, especially London, where African Barrick is listing, demonstrate a drooling pent up demand for gold and silver assets.

Fresnillo, which markets itself as the world's biggest primary silver producer, listed earlier in 2008 in London. Mexico's Industrias Peñoles, which raised hundreds of millions of dollars in cash from the listing, continues to hold 77% of Fresnillo, which has seen a market value topping the USD 10bn mark. The premium pricing of Fresnillo can be considered alongside the USD 391m operating cash flows that it produced in 2009.

But Fresnillo has been well coached in focusing on growth in ounces, with its longer-term objective "to maintain the group's position as the world's largest primary silver company, producing 65m ounces of silver and over 400,000 ounces of gold by 2018". In 2009 Fresnillo produced 38m ounces of silver, and 277,000 ounces of gold.

Indicative pricing for African Barrick suggests a market value of about USD 4bn, which would generate about USD 1bn in cash for Barrick when it departs with a 25% stake.

Now that gold miners have cashed their checques, all kinds of opportunities are going to be presented to investors. For years, gold miners have been trying to cannibalise each other, and, given the majority of accounts, sometimes themselves . . . and sometimes with success. But there's no such fun as when the gold gatekeepers turn into foxes, hairs on palms, and all. Run, chicken, run! Gallop, if you can!

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responses to this article

gold go by marco fila on March 11 2010, 08:44 Find this comment inappropriate? Report it

Gold Funny how these days we trade our gold (money) in for debt, and base it's value on fiat debt and central bank ponzi schemes. Man are we backwards these days. by ImagePhreak on March 11 2010, 13:00 Find this comment inappropriate? Report it

Gold value When all is said and done I understand that gold is still underpriced as mining companies are not making money which I already know for a long time, and on the other hand that the same companies are involved in stinking deals with the purpose of . .more milking the retarded who invest in them. But it does not take so much cackling to explain that. . .less by Muk on March 12 2010, 09:20 Find this comment inappropriate? Report it

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