DENVER ( TheStreet) --Two trends emerged from the Denver Gold Forum this year as gold prices trade around $1,300 an ounce: more consolidation and overvaluation. Merger and acquisition activity in the gold mining community is nothing new, but has definitely picked up steam in the past few years as gold prices soared past $1,000 an ounce. Most recently Goldcorp ( GG) and Kinross Gold ( KGC) bought Andean Resources and Red Back for $3.4 billion and $7.1 billion, respectively. Although the purchases represented hefty premiums, the large gold companies were forced to replenish their resources as gold demand skyrocketed and supply waned. The above-ground supply of gold has slowly shrunk since 2001, leaving gold producers in a bind. According to the World Gold Council, mine supply increased only 3% in the second quarter of 2010 while total gold demand rose 36%. The more gold a company produces, the more replacement gold it has to find, and organic growth on a big scale is hard to come by. It can also take 10 years to discover a mine and take it into production, so for a quick fix large companies have to turn to acquisitions. "The big companies need to replace ounces, and they're only going to do that through acquisitions," argues Mark Bailey, CEO of Minefinders ( MFN). "They don't have the patience to go out and make a grass-roots discovery. ... The big sized companies will have to acquire, the mid-sized companies will have to acquire ...
as well as smaller companies that want to grow quicker." Goldcorp paid a 35% premium for Andean Resources in its efforts to outbid Eldorado Gold ( EGO) for the company. Andean has indicated resources of 2.54 million ounces of gold. Shareholders will have to wait for the mine to be built before the acquisition will contribute to earnings. CEO Chuck Jeannes is estimating production by late 2012. Kinross paid a 21% premium for Red Back but will have immediate access to 450,000 ounces of gold from its already producing operations. The acquired West African miner, however, has initial reserve estimates of 25 million ounces. According to CEO Tye Burt, there is a 36-month plan to put the new mill into production while they are drilling. It will take about a year for Kinross to start adding this new gold to their production. Burt believes that more senior producers that don't have growth will follow in Kinross' and Goldcorp's footsteps. Projects will most likely be of higher quality and good grade.
There are many ways for investors to capitalize off of this trend. The most obvious choice is to bet on the small gold miners that will be bought, but that is like picking a needle in a haystack, especially because companies that are shopping themselves take on risk if there are no buyers. Another way, according to Tom Winmill, portfolio manager of the Midas Fund which is up 18% year to date, says to buy the large companies that have already acquired and gone through their growing pains like Goldcorp and Kinross. "Avoid the big ones that don't already have growth in their portfolio. Newmont ( NEM) comes to mind. Barrick Gold ( ABX) is kind of treading water on the growth profile.
Barrick probably won't do an acquisition but Newmont might." Another option to consider are royalty companies like Silver Wheaton ( SLW) or Royal Gold ( RGLD) as big purchases require lots of cash, and banks stay reluctant to lend. Peter Barnes, CEO of Silver Wheaton, told me that he expects continuing M&A to create business opportunities for the silver royalty company. "If company A wants to buy company B and they've got to offer some cash, they've got to get that cash from somewhere, and if they produce bi-product silver, we can pay them a lot of cash." Shares of Silver Wheaton are up 62% year to date. The other trend, which CEOs hinted at, is overvaluation. Although no names were mentioned outright, the idea is that as gold prices rise, huge value is put on small gold miners and developing properties that will mostly likely never materialize. "There is a concern in the manner in which ... the two drill hole wonders are attaching ridiculous amounts of capitalizations and the implications of that on the industry," says Paul Wright, CEO of Eldorado Gold. "I think there is the tendency of people to imply on limited information a value that in many cases won't be realized, and the market is getting ahead of itself." Mark Bristow, CEO of Randgold Resources ( GOLD), sees a similar trend. "I think we've got a lot of discordance in the gold industry if you look at the value that is being put on real producers ... and you look at the value that's put on promises ... it's all a little bit out of kilter." There does seem to be a sense of optimism, however, that there will be new gold discoveries especially as companies take a look at gold projects that were too expensive to work on when gold was at $400 an ounce but now, with $1,300 gold, provide value.
In general, there is definite gold euphoria in Denver, but the top CEOs remain cautiously optimistic. Bradford Cooke, CEO of Endeavour Silver ( EXK), says a lot of optimism is usually a sign of a short-term correction. "But
for the long term there is lots of time left in this cycle." -- Written by Alix Steel in Denver. >To contact the writer of this article, click here: Alix Steel. >To follow the writer on Twitter, go to http://twitter.com/adsteel. >To submit a news tip, send an email to: firstname.lastname@example.org.