Goldcorp's tie-up with Barrick shows the way forward...
BIG NEWS just broke in the gold sector, writes Byron King in Addison Wiggin's Daily Reckoning.
The story originated from industry bellwether Goldcorp (NYSE:GG). It involves a relatively complex set of mergers and business associations, but the bottom line is that a new bar has been set for how the gold mining industry works.
I believe that this new trend will affect the entire precious metal sector, from large mining concerns down to small juniors. Things are looking up for mining companies and their shareholders.
Here's the story: Last month, Goldcorp announced that it entered an agreement with Barrick Gold (NYSE:ABX) to develop a major, new gold-bearing mineral district called Maricunga. This area is located in the super-high, very dry Atacama Region of northern Chile.
Why is this important? Begin with three points:
- This deal is a major step for Goldcorp – entering Chile, taking the lead from Barrick and developing a vast, new precious metal district
- The deal marks a major teaming and risk sharing arrangement between Goldcorp and Barrick
- The deal sets a new bar for future merger and acquisition (M&A) activity within the mining space – paving the way for more of this style of M&A action with major companies, intermediates and juniors.
Goldcorp and Barrick – two elephants in the gold mining space – will set up a 50/50 joint venture to develop a string of projects in the heart of the Maricunga gold belt. This area is one of the world's largest undeveloped gold districts.
The joint venture aspect of this deal alone is important. Two big guys are laying down their corporate credibility, and sprinkling their holy water, so to speak, onto a nearly undeveloped mining patch. It's a sign that the Mining Zombie Apocalypse of the past five years is truly ending.
This Chile play is a structured deal with many layers. It begins with Goldcorp buying a 25% share in a project called Cerro Casale from Barrick, Goldcorp is also picking up another 25% stake in this project from Kinross Gold. This gives Goldcorp its "50," and leaves Barrick with "50."
The project itself holds eye-watering levels of gold, silver and copper – over 23 million ounces of gold, just shy 6 billion pounds of copper, and beaucoup silver. That's a heck of a lot of metal! Right away, you can see that this is a game-changer for Goldcorp. It doesn't just move the proverbial needle. It adds an entire new gas tank.
In addition to the Kinross and Barrick buys to obtain 50% of Cerro Casale, Goldcorp is using its own shares to fund a separate $185 million deal. It's buying a well-regarded, junior explorer-developer named Exeter Resource Corp. Exeter controls a site called Caspiche, which is also located in the Maricunga belt, about 6 miles north of Cerro Casale.
Caspiche also offers incredible levels of precious metal – about 24 million ounces of gold, 54 million ounces of silver and over 5 billion pounds of copper (although these numbers are lower than engineering confidence, at current stages of exploration).
The main focus on this new deal, however, is how companies must team-up to develop a gigantic resource of gold, silver and copper.
This Goldcorp-Barrick deal places a world-class level of new gold-silver-copper resource onto the global development table – tens of millions of ounces of gold-silver, and billions of pounds of copper. It comes after several years of investment drought, the Mining Zombie Apocalypse, when most miners were cutting budgets and shedding assets due to low gold prices.
The deal highlights the respective corporate cultures of Goldcorp and Barrick, which are quite different in many ways. In the past couple of years, Goldcorp has focused on boosting production. Goldcorp is driven by its internally-generated "Peak Gold" thesis.
This thesis is based on the fact that major discoveries dried up back in 1995. It takes about 20 years to go from discovery to production, so peak production hit in 2015. Goldcorp is trying to lock down as existing discoveries.
On the other side, Barrick has repeatedly stressed that its key company priority is improving cash flow through better margins. Barrick wants not just ounces, but highly profitable ounces.
According to Barrick president Kelvin Dushnisky, "This agreement will allow us (Barrick) to direct capital elsewhere in our portfolio, while ensuring shareholders retain exposure to the optionality associated with one of the largest undeveloped gold and copper deposits in the world."
Also, it's worth noting that, having inked its new joint venture with Goldcorp, Barrick is off the hook for most initial development costs associated with the Maricunga mineral belt project. Barrick has handed control of development to Goldcorp. It's a form of risk-sharing that evidently suits the respective management style of each company.
Both companies want to develop new resources while consolidating infrastructure to reduce capital and operating costs. The goal is to expedite permitting by showing how the development will reduce the environmental footprint, while at the same time create increased returns compared to two standalone projects.
In other words, there's no need to duplicate investment on two separate large-scale projects. It's capital discipline at work.
The most-important metric of any gold miner is cost per ounce. As long as a company can produce gold for less (preferably much less) than the daily price for yellow metal, they'll see cash flow and profits. At the end of the day, that's the idea.
Another angle on the foregoing is that a company's mining costs are almost immovably grounded during mine-planning and buildout. The ore body is laid out; pit size and/or shafts are dug; major equipment is bought and staged; labor inputs are established; chemistry and circuits are settled; all that, and much more, is done on the frontend.
After a mine is up, running, digging and processing, people who manage the place focus on keeping costs pretty much constant. Managers want no surprises. Miners seek a stable, level workforce, with predictable costs for equipment, fuel, supplies and the like. Sure everyone wants to improve and find new efficiencies whenever possible. But, at the very least, the idea is to keep costs on an even keel within the mine site.
This focus on cost-consistency, within day to day operations, is the key to understanding why gold mining companies and their profits are so highly leveraged to gold prices. A rising price for gold should put a Dollar-for-Dollar gain on the bottom line, if internal costs are stable (allowing for factors like royalties, taxes, etc.).
This helps explain why, when gold shares endure a sell-off like we've seen in the past two months, the bearish sentiment creates both impairment and opportunity. It's why Jim and I have not panicked at recent downward excursions for gold prices and/or mining share levels.
The mining sector may have drifted down, but costs remain about the same for producers. Nothing has really changed for nominal economics of advanced stage developers. Solid ore grades don't change with any market and low costs prevail.
With oil prices falling, we may see even better results in upcoming quarters due to future savings on energy costs. Meanwhile, gold pricing remains at least at a floor. And as Jim Rickards has noted, gold prices are likely heading up over time as the instability in global markets increases.
With Goldcorp setting a new pace for capital investment in a frontier region, and setting a new level for premiums in M&A, we can anticipate a solid spring and summer ahead for our gold miners.