Merger trends

It was said of Benjamin Disraeli that he spent more time arriving at Westminster than he spent in it. Consolidation in the gold industry is arriving, still. It has to be said: if Barrick’s taking over Homestake is “the big one,” how small will the rest of the mergers be?

One obvious comparison with the industry’s way of consolidating is the 1998 deal between the Royal Bank and the Bank of Montreal, which forced the Canadian Imperial Bank of Commerce and the Toronto-Dominion Bank into a deal; the Royal, the biggest bank, made the biggest deal, while those who waited made much smaller ones. Should that be the pattern the gold industry follows, then mergers such as Barrick and Homestake, or Newmont and Battle Mountain, and buy-in deals such as Normandy-Franco, are unlikely to leave us with the “three or four big players” that the big thinkers keep talking about. The only consolidation of the kind The Street appears to want must come from the larger producers. Only by turning the big six into the big three is an oligopoly likely to emerge.

The one way it might emerge is for the cash-rich among them to go on a buying spree. Barrick and Franco still have large cash accounts, as do Gold Fields and Placer Dome. AngloGold has money; Newmont has less. As nature abhors a vacuum, capital markets abhor big current accounts. That cash will go to buy something: for now, that’s likely to be the mid-tier producers.

Among them, the firmly unhedged Kinross Gold is cheap and has at least some good assets. High operating costs have kept its price low, while issues such as Meridian Gold and Goldcorp have shot skyward simply on speculation that the companies were takeover targets.

It also seems obvious for the Franco-Normandy alliance to draw in TVX Gold, of which Normandy already owns a large piece in the form of TVX-Normandy Americas. TVX is nothing if not low-priced.

Even so, buying up the mid-tier producers will cost money that the big boys might profitably use in buying each other. The clock is running down on share-trades, which will face less favourable accounting rules in both Canada and the United States this year. Hastily made corporate marriages might show up in the next month or so, but leisurely repentance after that will be no help to the gold market. Still, with so much talk surrounding consolidation for the last two or three years, it might be expected that virtually every company has sized up all the others by now.

It can be fairly said that there is no consolidation without South African producers. Even though the Wits basin does not dominate world production as it used to, it still provides close to a fifth of the world’s new gold.

Thus, a wild card in all this is the attitude of the South African government. In derailing the Franco-Gold Fields deal, it showed signs that it is not prepared to see South African houses lose even the appearance of a South African domicile — though that deal mostly combined two large bank accounts, Canadian and South African, and for the most part kept Gold Fields firmly in Johannesburg.

On the other hand, AngloGold and Anglo American have had little difficulty making a de facto corporate move to London, with hardly any noise from Pretoria.

If smaller Johannesburg houses such as Harmony or Durban Deeps find an attractive suitor elsewhere in the world, it’s hard to predict where official South African opinion will land. Should the government follow the same principles as in the Gold Fields case, the smaller South Africans can forget about not just offshore deals, but any deals: all the South African houses have widely differing philosophies, both on hedging and on the question of concentrating on low-cost production (like Randgold) or wringing profits from high-cost mines (like Harmony).

The subtext of consolidation-talk needs a closer look. It has generally been supposed that a 3- or 4-producer oligopoly would stop overproduction of gold and reverse the poor fortune that has been the yellow metal’s lot over the past decade. But is that really so? A few big producers could certainly close down uneconomic mines, but expensively produced gold is just a fraction of the gold supply. A few big producers might have the clout to push gold lease rates in a favourable direction, but for the hedgers, who largely hold the cards in this game, that direction is down, not up. A few big producers might even try for a diamond-style cartel, though gold is so widely held that a cartel could not hope to hold the gate when sellers start to appear.

One other thing is worth considering. It is fashionable to think that only the really big producers can be economic, but that is fantasy. Small gold producers in Canada, Australia and elsewhere have a record of mining cheaply and staying profitable. There will always be a place for the 100,000-oz. company — and if big producers start thinking big-and-only-big, that niche becomes ever more comfortable. Look for good junior producers to appear if consolidation really happens.

What can be hoped for the gold market is this: if and when large-scale consolidation does happen, mid-tier producers may be gobbled up, leaving just the biggest producers with the biggest mines. The smallest producers — the Rivers, Wheatons and Richmonts of the world — can then be counted on to show that small can still be beautiful in the gold business.