Making Sense of the Mega Merger ManiaJoe Foster, Portfolio Manager and Strategist05 March 2019
Gold rides momentum to new high
The gold price advanced in January following the US Federal Reserve’s dovish response to the December stock market volatility. This provided the momentum for gold to move to a new yearly high of US$1,346 per ounce on 20 February before pulling back to end the month at around US$1,313. However, gold has since dropped to about US$1,290. Following the yellow metal’s bright start to the year , it is too early to tell if the pullback is a consolidation within an uptrend, or a return to the range bound trading that has characterised the price pattern since 2013.
The strong central bank buying that characterised 2018 seems to continue. China purchased gold for the second consecutive month, buying about 12 tonnes in January. Azerbaijan nearly doubled its gold holdings to 100 tonnes. Meanwhile, Romania announced plans to move its 103 tonnes of gold reserves from London to local vaults.
Gold stocks slightly underperformed gold over the month. The NYSE Arca Gold Miners Index declined 1.6%, while the MVIS Global Junior Gold Miners Index fell 1.2%.
Stock market highs pose headwinds
The stock market has become a headwind for gold as the S&P® 500 is once again poised to make a run at new all-time highs. Complacency is creeping back, which weighs on safe haven investments. Every Fed chair since Alan Greenspan has been accused of protecting the stock market with monetary policies. Incumbent Jerome Powell was thought to be more hawkish and immune to the whims of the market when he took office. However, the Fed’s policy pause in response to stock market volatility in December has shown Powell to be as sensitive to the markets as his predecessors. David Rosenberg of Gluskin Sheff, an independent Canadian wealth management firm, believes the proliferation of exchange traded funds (ETFs), quantitative models, algorithmic trading, and momentum investing are all perpetuated by central bank suppression of risk premia, creating artificial market conditions where pricing is divorced from fundamentals. Ten years after the financial crisis economies are so fragile that central banks are still being called to the rescue.
Weakness in housing, automobiles, retail, and manufacturing combined with the lagged effects of the Fed’s tightening in 2018 could again weigh on the stock market this year. Another selloff might may be the catalyst that gold needs to break through its price range.
Newmont/Barrick: From supermajors to super-duper major… or not?
M&A activity in the gold industry may have peaked. It started with the September announcement of the friendly merger between Randgold Resources and Barrick Gold, which was essentially a reverse takeover that left Randgold’s management in charge of the new Barrick. Then, in January, Newmont announced a friendly takeover of Goldcorp, which is scheduled for a shareholder vote in early April. In each case, the managements of Randgold and Newmont believe they can do a better job of creating value than the previous managements of their respective takeover targets.
Barrick and Newmont have spent the past five years downsizing by disposing of non-core properties, streamlining management, and strengthening their balance sheets. Now, in a stark reversal of strategy, they want to grow through mega-mergers. Newmont’s management style is akin to a modern corporate structure, while Barrick under Randgold is more decentralised and entrepreneurial. Each believes their respective management and assets are superior. We will look at their quarterly results for evidence of their success, or lack thereof, in unlocking value. In time, we will find out if their focus on shareholder returns, operating discipline, and innovation are enough to ensure success, and whether one is more effective than the other. We hope competition in the free market brings out the best in both.
In addition to the considerable skills needed to manage so many mines, it may be geologically impossible to sustain a gold company that is as large as these companies are becoming. Barring mergers, the size of a gold company is fundamentally limited by geology. The tier-one properties (with low-cost reserves of over five million ounces) that make up the core of the supermajors’ portfolios are freaks of nature and extremely rare. Gold deposits are generally limited in size and often discontinuous, with chemistry and rock conditions that can be challenging to manage. Companies have been searching for tier-one gold deposits for nearly 200 years and the surface of the planet has been thoroughly explored. They must search deeper - with less success - as discoveries become fewer every year.
Barrick’s hostile no-premium bid for Newmont is contingent on cancelling the Goldcorp deal. Barrick believes it can unlock value in Newmont that would not surface if the Goldcorp transaction is allowed to proceed. This would create a super-duper major the likes of which have never been seen before in this business. Shareholders will soon decide whether Newmont is better off with Goldcorp or Barrick.
Barrick figures that roughly two-thirds of the added value of a merger will come from unitising its Nevada operations. Newmont and Barrick combined produce about four million ounces per year from the state of Nevada, one of the most prolific gold regions in the world. Within Nevada, Barrick has higher production and lower costs, while Newmont has more processing infrastructure. Without Nevada, most of the rationale for the merger disappears.
While we do not know whether Barrick’s bid for Newmont will be successful, it does focus attention on the potential gains that unitising Nevada would generate for both companies. My experience as a geologist in Nevada, and knowledge of the two companies, suggests there is significant value to be gained from merging their Nevada operations. However, given that shareholders do not have the data, resources, or technical expertise to comprehensively evaluate such a colossal project, they will have to rely on the managements to do the work for them. Newmont has released a Nevada joint venture term sheet in response to Barrick’s hostile offer, which the latter has yet to respond. If these two adversaries cannot come to terms on Nevada, we call on them to prioritise their shareholders’ interests by publishing a joint definitive feasibility study that quantifies this value and articulates plans to unlock it. Once this is done, the best path forward should become obvious.
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