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The Gold Stock Strategist analyzes leading junior gold producers and major gold mining companies.

Comments are welcomed!

Sunday, April 27, 2008

Emerging Producers Ripe for Consolidation

I have written in the past that 2008 should be the year of consolidation for the gold mining industry given the flush coffers of the majors and the large number of severely undervalued emerging junior gold mining producers.

The following article, though almost a month old, supports the consolidation thesis. Many of the names should be famnliar to those investing in the junior gold mining space.

Tomorrow, I will be posting a valuation of a new undervalued emerging junior gold mining producer. Stay tuned!


Gold Stock Strategist

Big miners could be on the prowl
Globe and Mail Update
April 4, 2008 at 6:00 AM EDT

Investors in the mining sector may have been too busy salivating to notice, but metal commodity prices haven't been the only thing going through the roof. The costs of developing new mines have also been soaring – and that could foreshadow a new round of takeovers in the sector, analysts at RBC Dominion Securities Inc. said yesterday.

The investment bank's mining group issued a report showing that in the past year and a half, capital cost estimates for major mining projects under development have surged by an average annualized rate of more than 56 per cent.

Much like Canada's oil sands companies (which are, for the most part, essentially developing mining projects), mine developers are being hammered by surging labour costs amid acute shortages of skilled workers, as well as sharp increases in costs for materials. Costs for steel and cement have risen by as much as 40 per cent annually over the past two years, the report said.

One of the most glaring examples of these runaway costs is right here in Canada. The estimated capital budget for the Galore Creek copper/gold project in British Columbia has jumped from $1.1-billion in the fall of 2005 to a whopping $5-billion today – prompting the project's owners, Teck Cominco Ltd. and NovaGold Resources Inc., to put the project on hold while they seriously rethink the whole thing.

But the cost increases are hardly unique to that project or even this country. New mine developments in such far-flung places as Alaska, Australia, Panama, Romania, Russia and Papua New Guinea have seen project cost estimates soar over the past year, in many cases doubling or even more.

“We do not believe an end is in sight,” the RBC analysts said.

This is creating a very risky and expensive environment for embarking on new mining projects – and this, the analysts believe, is creating the impetus for takeovers.

The pieces of the argument fit together nicely. Mining companies, especially big senior names, are kicking off cash like never before, thanks to record commodity prices. Cash flow at such mining giants as BHP Billiton Ltd., Barrick Gold Corp. [ABX-T] and Xstrata PLC have more than tripled in the past three years.

But these seniors have the same problem they have always had: They have mature mines whose resources are dwindling yearly, and to keep their businesses growing, they have to find ways to replace those depleted reserves and then some.

Developing new mines is all fine and good, but why bother when development costs are skyrocketing? Why not put all that loose cash to work buying existing assets that are already late in the development process? You've got the cash to pay for it, the risk is reduced, and the reward can be realized much sooner.

“Companies looking to expand production, or replace a declining production profile, may be better off acquiring companies with one or more late-stage development projects, rather than funding existing early-stage projects all the way through development,” the analysts wrote.

“The most likely targets for M&A in the short term will likely be companies with established production and/or reasonably near-term growth certainty,” they said.

On the top of that list is Kinross Gold Corp. [K-T], which has a couple of projects (Kupol in Russia and Paracatu in Brazil) slated for completion this year. With a market cap of $14-billion, Kinross would probably be a mouthful for all but the biggest of mining companies. But the RBC analysts also mention some smaller names that fit the mould – including Centerra Gold Inc. [CG-T] and Eldorado Gold Corp. [ELD-T]

Even if these companies don't get taken out, they could still offer nice near-term growth with relatively low development risk. Other stocks fitting this description include Agnico-Eagle Mines Ltd. [AEM-T], Jaguar Mining Inc. [JAG-T], Anatolia Minerals Development Ltd. and European Goldfields Ltd., the analysts said.

On the other hand, RBC cautioned investors to be wary of capital-intensive projects that are years away from completion.

That flashes a yellow light over Barrick. The gold mining giant has three such projects that fit this risky profile: Donlin Creek in Alaska, Pueblo Viejo in the Dominican Republic and Pascua Lama in Argentina/Chile.

“We feel such long-lead-time projects are unlikely to be sought after until permitting and timelines are better delineated,” they said.

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