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Gold Stock M&A: How to Play It

Stocks in this article: ABX KGC

NEW YORK ( TheStreet ) -- High gold prices have triggered a wave of mergers and acquisitions in the gold mining sector, and there are four ways one could profit from this consolidation wave:

  • Short the buyers and potential buyers;
  • Buy the buyout targets;
  • Buy the large miners that already have made big purchases;
  • Buy the mid-tier miners who focus more on organic growth rather than buyouts

First off, M&A for gold miners is here to stay as long as gold prices stay high. The stronger the gold demand, the more gold a company must produce, the more gold it has to find to replenish supply.

According to the World Gold Council gold demand trend report, mine supply grew 3% in the third quarter compared to a year ago while gold demand rose 12%. Although the difference between supply and demand was largely made up for by an increasing recycled gold supply, as prices sustain high four-digit levels the pressure is on to find new deposits.

Gold Stocks to Buy as M&A Heats Up

Using rough math, if a producer wants to increase its annual production by 1.5 million ounces a year, the miner must find twice as many ounces of resource. CEO of Novagold (NG) Rick Van Nieuwenhuyse says "typically resources to reserves is about 60% and you get about 90% recovery."

Finding a new mine and bringing it into production can take upwards of 10 years during which time the company must contend with geopolitical and environmental risks, which could slow the project down. Some companies get lucky like Endeavour Silver (EXK) which took its Lucera mine from discovery to production in four months, a pretty rare scenario.

Another option is partnering. A senior miner can partner with a junior on a new project to help shoulder some of the financial burden while reaping the benefits of someone else's work. Paolo Lostritto, mining analyst at Wellington West Capital Markets, thinks that this strategy, however, is just a fallback.

Juniors might enter into a partnership expecting the richer company to jump-start the project into production, but since the senior typically has a longer production time line (maybe it won't need more gold deposits for 10 years) sometimes an asset just sits there. "A buyout is more beneficial for a junior ," argues Lostritto.

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