The mood at the Denver Gold Forum was reminiscent of the week following September 11, 2001. Both mining equities and metal prices continued their decline with much talk but little action by bullish investors. We were reminded of the adage that “a bear market ends with the capitulation of the last bull” which may suggest we are on the cusp of one of the greatest investment opportunities in years.
We have seen several points on the calendar as catalysts for the mining sector. One, being the Olympics in Beijing, where China demonstrated its determination to show itself as a leader on the world stage in culture, sports, and economics. China’s impact on the future, and appetite for precious, base, and industrial metals, is now apparent to anyone with a television. Secondly, as the summer holiday season comes to a close, the investment community is now back at work, and the seasonal period of increasing global gold demand has commenced. Lastly, the Denver Gold Forum provided the platform to for consolidation which might draw investment funds into the sector setting off the next bull market.
The keynote speech at the Denver Gold Forum presented both fundamental and technical justification for an inflection point for both metals and mining equities. Clearly, well discussed themes of declining gold production and increasing investment demand were reiterated. In addition, a macroeconomic environment including low real interest rates, global financial imbalances, and declining faith in global currencies remains an important component of the thesis for holding tangible assets. An imbalance exists where gold equities of $230 billion now represent only 0.02% of global financial assets. Even more important, the market cap of physical gold of about $4 trillion is now only 4% of global financial assets. This historic low suggests that the metal and mining equities are likely undervalued relative to global financial assets remain substantially overvalued.
In general, corporate presentations at the conference recounted significant milestones and meeting guidance while admitting the unhappy reality of lower stock prices sector wide. We were impressed with the leadership of the majors for the long-term stability of the industry, though it was clear to us that projects in the pipelines of the majors would not be sufficient to reverse a trend of lower gold production. Both Barrick Gold Corporation’s (NYSE:ABX) and Goldcorp Inc. (NYSE:GG) forecast gold prices of $1,500 per ounce in one to two years. Each major producer boasted containing operating costs, and margin expansion leading to increased cash flow. Considering the fall off in equity prices, and the bullishness of the industry insiders, companies with attractive projects should be even more attractive for takeover.
On the first day of the conference, Barrick announced the sale of $1.25 billion in debt to clear its primary bank credit facility. This may be more than simply sensible balance statement management, but as a means to resume the hunt for replacement reserves through acquisition. It was reported in the Barrick corporate presentation that they had an appetite for acquisitions in North America. It would follow that this would include larger projects with potential for near term production. We were surprised not to hear more about Barrick’s interest in Donlin Creek where a substantial amount of their growth in 2009 is expected to come from converting gold ounces to reserves. Having failed to takeover NovaGold Resources Ltd. (NYSEMKT:NG) in 2007 at a price of $16 per share, at current prices, acquiring NovaGold to capture the remaining share of Donlin Creek appears to present the least risky path for reserve replacement for Barrick.
NovaGold and Barrick each have a 50% interest in the Donlin Creek project in Alaska. Barrick has spent over $200 million in developing Donlin Creek and they are scheduled to complete a feasibility study early in 2009 that would advance about 32 million ounces of gold to reserve status. Previously, Barrick acquired Arizona Star, and about a 50% interest in the world class Cerro Casale project in Chile, for $800 million, or roughly $54 per ounce. A premium over that valuation would be justified to complete a 100% interest in Donlin Creek. This would suggest a takeover price in excess of $900 million. This would not include value for production at NovaGold’s Rock Creek project in Nome, Alaska, or for imminent resumption of development of the Galore Creek project in which NovaGold has a 50-50 ownership position with Teck Cominco Ltd. (NYSE:TCK). With increasing seasonal demand for precious metals, and near-term production and development events, Barrick may not have much time to acquire opportunities like NovaGold at a premium to the current 52-week low.
We are also intrigued by Detour Gold Corporation (OTCPK:DRGDF) which recently announced a technical report on its Detour Lake project in northeastern Ontario. The report contemplates a 30,000 tpd to 60,000 tpd operation mining a ten to fifteen million ounce gold resource (depending on cut off and metal price assumptions) and a mine schedule of at least sixteen years based on the currently identified resource. The deposit remains open and assays are pending on step-out drilling. Two other significant resource names that we believe have considerable undervalued gold assets and have recently hit 52-week lows include emerging producers, Etruscan Resources Inc. (OTC:ETRUF) and Minefinders Corporation Ltd. (MFN).
We are also reminded of the tremendous buying opportunity which followed the resumption of trading following September 11, 2001. Unlike that event, significant investor anxiety due to ongoing concerns in the financial sector may persist for the balance of 2008 providing an opportunity requiring careful stock selection. With seasonal increases in demand for precious metals and/or potential acquisitions, the correction in mining sector may be short-lived.
Disclosure: The author is long NG, EET, and MFN. An affiliate of the author's employer provides corporate advisory services to NG, EET, and MFN.