A brisk wind of investment dollars is blowing in the direction of junior mining, as the sector recovers from close to a decade of neglect from retail and institutional investors who, enticed by better opportunities, put their money elsewhere, like pot, bitcoin and blockchain.
Before we get into the evidence of a fresh round of junior miner deal-making that started in December and has rolled into the New Year, it’s fascinating to look at how the uptick in mining M&A, particularly gold mining, has not actually translated into an increase of global metal reserves. Reserves are just being shifted from one company to another, with no net gain globally. On top of that, the majors and mid-tiers are spending their extra cash on mergers and acquisitions, bigger always being better, at the expense of exploration budgets which are being severely cut. Throw in the lack of investment capital being allocated to juniors, the owners of the world’s future mines, and you get the mining industry’s most significant challenge: how to replace the metal from depleted mines when there is so little money being allocated to exploration?
Record year for gold M&A
2019 was a record year for gold mining M&A. According to a report from Bank of America Securities, deal-making in the gold sector totaled US$20.2 billion, the highest in 9 years. The year’s transactions were double 2018’s $10.46 billion and nearly four times more than deals worth $5.87 billion in 2017.
Why the sudden urge to merge? Mining companies, especially in the gold space, have realized that since the vicious 2012-16 bear market, they have slashed costs as much as they can and the next step is to bring assets and companies together. On top of that, the top gold miners are running out of reserves, and are looking to replace them with high-margin projects that have the right combination of grade, size and infrastructure.
A 2018 report from S&P found that 20 major gold producers had to cut their remaining years of production by five years, from 20 to 15, based on falling reserves. The 10 largest gold mines operating since 2009 will produce half of the gold as a decade ago.
It’s not surprising that gold companies are finding it tougher to add to reserves; much of the easy-to-mine gold has been discovered.
According to McKinsey & Company, in the 1970s, ‘80s and ‘90s, the gold industry found at least one +50Moz gold deposit and at least ten +30Moz deposits. However, since 2000, no deposits of this size have been found, and very few 15Moz deposits.
Any new deposits will cost much more to discover. This is because they are in far-flung or dangerous locations, in orebodies that are technically very challenging, such as deep underground veins or refractory ore, or so far off the beaten path as to require the building of new infrastructure from scratch, at great expense.
The costs of mining this gold may simply be too high.
Moreover, gold grades have been declining since 2012, meaning more ore has to be blasted, crushed, moved and processed, to get the same amount of gold as when the grades were higher, significantly adding to costs per tonne.
Add to this the practice of high-grading where, instead of mining a deposit as it should be, economically, by extracting, blending both low-grade and high-grade ore at a given strip ratio of waste rock to ore – the company “high-grades” the orebody by taking only the best ore, leaving the rest in the ground.
Totaled up, these factors explain Barrick combining with South Africa’s Randgold, the Barrick-Newmont joint venture in Nevada, the $10 billion fusing of Newmont and Goldcorp, Newcrest’s 70% purchase of Imperial Metals’ Red Chris mine in British Columbia, and other 2019 examples of gold M&A.
According to the Refinitiv Eikon database, gold-mining companies in 2019 spent $30.5 billion on 348 merger or acquisition deals, nearly $5 billion more than in 2010, the height of the mining supercycle.
At the expense of exploration $
A gold industry consolidation has been expected for years. But the big news is not so much the surge in deal-making, but the loss of exploration dollars. S&P Global, a news and data provider, found that as M&A soared, gold exploration budgets shrunk by nearly an eighth, wiping out most of 2018’s growth in boots-on-the-ground activity.
Why was there such a decline? Because the large and medium-sized companies are “eating each other”, acquiring companies and/or projects, merging into larger firms that end up with a higher reserve base. These new, bigger producers need not invest in exploration, like they were pressured to do before the merger or acquisition. S&P metals and mining specialist Mark Ferguson explains:
“M&A activity has played a critical role in lowering planned spending [because] exploration budgets by the combined entities are much lower than the collective amounts allocated pre-merger by the individual companies.”
An analysis by BullionVault found that third-quarter 2019 production from Newmont Goldcorp and Barrick (now combined with Randgold) fell 9.2% from the four pre-merger corporations’ Q3 2018. The mergers also trimmed over $100 million from their pre-merger exploration budgets.
The consequence of this is significant.
“Miners are buying each other out, but they’re not investing in a lot of new capacity,” Bart Melek, global head of commodity strategy at Canadian brokerage TD Securities, said in a presentation to the London Bullion Market Association. “So what we could very well have [in 2020] is a situation where gold doesn’t flow from inventory into the broader market.”
Just so we’re clear, the majors and the mid-tier gold companies are combining into larger entities in order to boost their reserves. They need to do this to stay profitable. Majors are selling “non-core” assets that no longer make economic sense to mine, either to another major, or to a mid-tier, whose ounces get added to the buyer’s reserves.
However, these reserves are not new, they are already on the books of the acquiree. The global inventory of gold reserves has not changed, the reserves have just shifted from one company to another. They are quite literally robbing Peter to pay Paul.
Moreover, when gold prices move up mine owners mine the lower grade ore, tonnage milled is the same, costs to mine are the same but less gold is produced – creating less ounces available for investment purpose, central bank buying and jewelry-making.
In sum, M&A combines reserves, at the expense of exploration spending, thereby making it harder to replace reserves that are currently being mined out. At the end of the day, global supply is unchanged, or it may even go down, if reserves depletion exceeds supply from new mines.
This shift in ownership of gold assets, through M&A, is also happening in a number of other mined commodity markets. There was Pan American Silver’s $1.07 billion cash-and-stock acquisition of Tahoe Resources, the $1-billion deal for Lundin Mining to acquire a Brazilian copper-gold mine from Yamana Gold, and the 2018 merger of PotashCorp. and Agrium, to create fertilizer giant Nutrien.
Junior mining financing flickers to life
2018 was a tough year for stock markets, especially mining equities, whose aggregate valuation declined 12.7%, compared to a 10.8% decrease in the market capitalization of the entire TSX market, states PwC in its report, ‘Shifting Ground’. Prices of base and precious metals, as well as cobalt and lithium, all fell.
However, Most mining issuers began to rebound in step with a broader market comeback and had recovered 2018 losses by the first quarter of 2019, writes PwC.
The better performance had higher metals prices to thank. Copper, zinc and nickel managed significant gains in the first few months of 2019. Gold rose 18% for the year, silver 13%, and palladium vaulted a whopping 49%.
In June, Kingsdale Advisors noticed the mega-merger mania of early 2019 had spilled into the juniors and intermediate-producers. In Q4 2018 and Q1 2019, there were over $US15 billion in gold industry deals involving Canadian-listed companies.
In fact according to mining financing statistics sourced by AOTH, commentary from junior mining thought leaders, and a “show me the money” demonstration of confidence in gold exploration companies by a certain resource billionaire, juniors appear to be back in the game, cashed up and ready to explore.
As proof, consider how the steady rise in the price of gold last year, from around $1,300 to $1,500 an ounce, inspired mining money man Eric Sprott to take a number of positions in micro-cap gold companies.
Sprott jumps in
In 2019 Sprott went on a junior spending spree. Ever the contrarian investor, when most other investors had shunned precious metals, over the course of a few months, Sprott splashed $200-$300 million on about two dozen companies, mostly TSX Venture-listed gold explorers, including $32.9 million on Continental Gold – later acquired by China’s Zijin Mining for CAD$1.3 billion.
According to junior mining finance tracker Oreninc, between May and July, his $139.5 million in investments represented one in four dollars raised by junior miners.
How’s that for a vote of confidence in the future of the sector? When Sprott spends this kind of money on juniors, the market tends to listen.
It’s interesting to read Sprott’s comments about his moves in the gold sector last year. In an interview with Financial Post reporter Gabriel Friedman, Sprott says when the gold price goes up, he doesn’t even consider investing in large gold producers, especially lower-cost ones. That’s because cost-savvy, high-margin gold miners are already raking in billions; when gold goes up, they are only going to see incremental gains. Friedman reports on Sprott’s investment tactic, which is very similar to us at AOTH:
The best-run companies might provide 20- or 30-per-cent returns, or maybe 100 per cent in a few cases, but Sprott would rather invest in a company that might strike gold and give him a 500-per-cent return, or even a coveted 1,000-per-cent return.
2019 was certainly the perfect year for an angel investor like Eric Sprott to emerge. Coming out of 2018’s slump in several commodities, due mostly to the uncertainty associated with the US-China trade war, last year we saw very strong performances from gold, silver, copper, palladium, nickel and zinc – having correctly predicted price corrections for each.
While it’s disappointing not to see a rising tide of junior miner stock prices to accompany these bullish calls, we continue to believe.
The juniors’ place in the mining food chain is to provide projects to be turned into mines for larger mining companies whose reserves are running low. This is becoming a growing problem as all the low-hanging, high-grade deposit fruit has been picked. Such is the case for gold, silver, copper, palladium, zinc and nickel, all of which are encountering, or will shortly encounter, supply deficits, amid booming demand for battery metals and precious metals.
Finding the kind of grades at amounts that will make a mine profitable usually requires going farther afield or deeper – greatly adding to costs per ounce or tonne.
Here’s the problem juniors have been facing: At the same time as investment capital has been pulled out of the mining majors and mid-tiers – by investors tired of seeing falling or stagnant stock prices/ red ink balance sheets – there’s been a dearth of speculative capital flowing into exploration companies.
The ascendance of index funds has also made it harder for juniors to attract money, because they are too small to be in the funds that these vehicle track.
According to a 2019 report by PDAC – the association that puts on the annual mining show in Toronto – and Oreninc, equity financing in 2018 was 35% less than in 2017 – a decade-low $4.1 billion.
A good chunk of that cash went to marijuana stocks, as dozens of companies emerged to take advantage of the pot legalization bill passed by the Canadian federal government. Whereas weed stock IPOs attracted $491.1 million in investment dollars in 2018, mining IPOs only accounted for $51.6 million, a startling drop from the $830 million in 2017.
That’s a lot of speculative capital pulled out of resource stocks.
However it’s not all gloom and doom. Although the cost of capital for juniors is about triple that of larger capitalization companies, some explore-cos have shown creativity in how they attract investors’ dollars.
In 2018, Victoria Gold closed a $505 million financing package to fund Eagle – the first gold mine in the Yukon Territory – through a combination of funding sources. These included two credit facilities from Orion Mine Finance for CAD $219 million, a royalty deal with Osisko Gold Royalties worth $98 million, an equipment financing package with Caterpillar totaling $63 million, and two private placements, one with Orion for $75 million and $50 million with Osisko.
A different approach worked for Harte Gold’s Sugar Zone project in northern Ontario, 80 km east of the famed Hemlo camp. The gold junior managed to secure US$70 million in financing from two private equity funds – a $50 million senior secured debt facility with Sprott Private Resource Lending, and a $20 million loan from Appian Natural Resources Fund.
Some, including us, think the wave of mergers and acquisitions that swept up the gold sector in 2019 will find its way to the juniors in 2020.
In a December video interview with BNN Bloomberg, Sprott CEO Peter Grosskopf said because many junior gold explorers are priced so cheaply, he expects the number of deals involving smaller gold companies to get a bump in 2020.
“[This] year I’ll be looking for a trickle-down effect, the majors are still selling non-core assets but they also might buy occasionally, the intermediates are going to buy, merge, and the juniors are going to get bought, and merge as well.”
Among the first M&A of 2020, Alamos Gold paid $1.1 million for an 11% stake in Red Pine Exploration, and China’s JCHX Mining Management took a strategic interest in Cordoba Minerals, developing its San Matias copper-gold-silver project in Colombia.
Analyzing data from Oreninc, we find deal-making, especially in the gold space, heating up in December. Of the top 10 largest financings closed last month in Canadian capital markets, gold accounted for seven.
According to Oreninc, Osisko Mining led with $61 million raised in December, followed by Integra Resources at $25.3 million and Skeena Resources at $16 million. The top 10 gold financings accounted for $168 million, 218% more than the $52.9 million in deals signed in November.
The base metals sector also attracted some much-needed investment capital last month. Led by Regulus Resources and Osisko Metals, the top 10 base metal financings raised $36.2 million, which is a 723% jump from the scant $4.4 million raised in November.
For the week ending January 2, of 33 financings, Para Resources arranged a non-brokered private placement for up to CAD$5 million, Regulus Resources closed an $11.5M offering, and Benchmark Minerals closed a $6.15 million offering underwritten by a syndicate led by Sprott Capital Partners.
In many aspects of life, questions can be answered by following the money. Doing so yields a few key points about the status of junior mining at the beginning of 2020.
The first is that the juniors are being sacrificed on the alter of larger-company M&A. In this article we proved that, as large or intermediate gold producers combine or get acquired, and divest themselves of mine properties, the acquiree’s reserves are simply shifted to the acquirer. Nothing new has been created. The global inventory of gold reserves has not changed, the reserves have just shifted from one company to another.
The low rate of discovery along with drastically less capital to put towards exploration, has left the industry with a weak pipeline of development projects. And there’s another problem: It is taking longer, much longer, to commission greenfield mines. While it used to take 12 years to bring a new discovery to production a decade ago, today it will be 20 years. Some mines in sensitive jurisdictions, like the US and Canada, requiring copious environmental studies and special interest group sign-offs, could take up to 30 years!
If the industry is to successfully keep enough reserves in the hopper, so to speak, to replace those used up by mining, it had better get exploring, now. Copper, zinc, palladium, silver, cobalt and sulphide nickel are metals currently, or well on their way, to facing serious supply shortages. If we are to avert a supply crunch, money needs to flow to the juniors and they need to get exploring, today. There is no time to waste.
The same goes for gold.
In a previous article we showed that, even though major gold miners are high-grading their reserves (mining all the best gold and leaving the rest), even hitting record gold production in 2018, they still didn’t manage to satisfy global demand for the precious metal, not even close. Only by recycling 1,173 tonnes of gold jewelry could gold demand be satisfied.
Now the question becomes, how do we, or can we close that 1,000-tonne (for round numbers) gap? M&A isn’t the answer, because it’s not creating any new reserves. The only companies that can, they do it better than majors or mid-tiers, are the juniors.
That brings us to the second point. Smaller mining deals are starting to be inked, compared to the big mergers we saw happening a year ago. Osisko Mining, the top gold deal-maker from December, has a market value of only $1 billion. Newmont Goldcorp’s market cap is 44 times as large, Barrick is 40 times the size.
Alamos Gold, the company that bought Red Pine Exploration earlier this month, is valued at $3 billion. Osisko Gold Royalties, $2 billion market cap, in September bought Barkerville Gold Mines, a BC-based junior, at a 44% premium.
Further down the food chain are deals done by Palladium One (TSX-V:PDM), Getchell Gold (TSX-V:GTCH) and Max Resource (TSX-V:MRX).
The third point concerns the gold market. Financings, mergers and acquisitions have overwhelmingly involved gold miners and gold explorers, and will likely continue to do so this year. This isn’t surprising considering that gold has risen 20% over the past year, but gold stocks have failed to keep pace. These companies are are on sale. The buyers are, and will be lining up for the best projects, that can deliver size, grade, scalability, longevity and infrastructure.
Consider that for juniors, acquisitions typically occur at a 30 to 40% premium to the stock price. As peer group comparisons are made to companies being acquired, I expect significant re-ratings to occur.
Richard (Rick) Mills
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