Go Big or Go Home
By Bob Bishop
11 Sep 2006 at 02:00 PM EDT
LAFAYETTE, Calif. (GoldMiningStockReport.com) -- Though we are emerging from a summer market that was quiet but not without bright spots, there is no question about the predominant theme in mining in recent months: consolidation.
The battle for nickel miners Inco [NYSE:N; TSX:N] and Falconbridge [NYSE:FAL; TSX:FAL], the eventual winner of the latter by Xstrata [LSE:XTA], Teck [NYSE:TCK; TSX:TCK-B] being in the mix before bowing out, and the still ongoing battle for Inco has dominated the deadlines since the spring. Copper, nickel, iron ore; do you detect a theme?
While most of the consolidation headlines have occurred in the base metals sector, acquisitions also continue in the gold universe-Barrick Gold's [NYSE:ABX; TSX:ABX] July 24 bid for Novagold [AMEX:NG; TSX:NG] and Yamana's [AMEX:AUY; TSX:YRI] mid-August bid for Viceroy [AMEX:XVE; TSX:VYE] come to mind-and ten days ago, Goldcorp [NYSE:GG; TSX:G] agreed to acquire Glamis Gold [NYSE:GLG; TSX:GLG], a friendly deal that will create the world's number three gold producer. If the wave of consolidation were happening as it did 25 years ago, when cash-rich oil companies waded into the mining sector, I'd be especially wary of what the urge to merge may be signaling this time around. If other cash-rich companies were using their billions to into the mining sector instead of into the share buybacks that have been propping up the broader market; that too would be of concern.
However, instead of cash-rich outsiders sensing opportunity in the mining sector, only to come away with the realization that they were buying the top of the market and that the mining industry is a tough way to make money, this time around it is those who know the industry best, and I think there are other lessons to be learned:
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High commodity prices have produced windfalls for many producers, and they are putting the proceeds to long-term use. It is an implicit vote of confidence in the staying power of high commodity prices, and a statement that the major producers believe the cheapest metal to be discovered resides on the floor of Canadian stock exchanges.
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A corollary to the above is that new discoveries are increasingly hard to come by, and that buying one's future with a checkbook or shares is much easier to accomplish than is finding future reserves at the end of a drill bit. The easy discoveries have been made, perhaps especially so in the case of gold and nickel, and the relative absence of new discoveries means that the consolidation trend is likely to continue. Buying the metal resources of tomorrow will continue to be easier than finding them-and this doesn't even begin to address the challenges of bringing new discoveries to account.
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While the American press, NGOs (non-government organizations), environmental groups, and local constituencies all serve to slow the process of bringing new mines on-stream, and are thus unwittingly and tremendously supportive of the current commodity cycle, one of the side effects of the consolidation underway in the sector is that when two companies become one, there's one less exploration department at work in pursuit of tomorrow's mineral discoveries.
Most of the larger companies conceded long ago that they cannot compete with juniors, and even if the concession hasn't been made, exploration is not a priority because it doesn't pay its own way. In short, fewer exploration departments will only exacerbate the already constrained new supply pipeline for the commodities of tomorrow.
Still Longer & Stronger?
Some of the preceding comments are supportive of what I've often described as the ‘Longer & Stronger’ commodity cycle, what some refer to as a commodity “supercycle.” As someone who sees things from the generative end of the spectrum, and appreciates how truly difficult this business called mining really is, it is perhaps especially easy for me to subscribe to the idea that the current cycle continues to have years in front of it. As investors in the sector, waiting on permits, drill rigs and drill crews, assay labs, regulatory hurdles to be resolved, and for personnel that often simply aren't available to do the necessary work, you should likewise have little trouble buying into the idea that the current cycle is constrained in ways that all but seem to assure its continuation.
From the ground up, I think that's an inescapable observation. It's also an industry-centric conclusion, one that doesn't take into account current and future economic conditions. The current economic slowing, most evident in the U.S. real estate market but having implications far beyond it, is likely to be more apparent once the November elections are out of the way. In between now and then, spin and data manipulation will be in overdrive, and reality is likely to be increasingly far removed from the message emanating from the current Administration. Economic realities, none of which are playing out in favor of Republicans, appear bleaker each week, especially to those who have overreached in real estate during the easy money days of recent years.
The May market meltdown prompted many to begin saying that the commodity cycle was over, and in view of increased signs of the U.S. economy slowing since that time, there is a growing concern about how a bull market in commodities continues in the face of a slowdown that appears to be disastrous for many of those leveraged in real estate, and the ripple effects that can be expected to resonate elsewhere in the economy. Not being an economist, I hesitate to make broad pronouncements on such matters, but I would like to make a few observations. Most of the world's leveraged problems, be they derivative time bombs or their equivalent in the realm of
real estate, are concentrated in the United States.
The world's biggest debtor does have some major issues before it, but I don't buy into the U.S.-centric thinking that, to paraphrase Reggie Jackson's famous description of himself, the United States is the straw that stirs the drink. Instead, an analogy I heard recently seems much more appropriate: think of a hook-and-ladder fire truck, the ones that have a tillerman on the back end, guiding the rear of the truck around corners. These days, that truck is being driven by a Chinese guy with an Indian seated next to him; an American is steering the back end, and will probably hit some curbs and take down a few light poles-but he's not been driving the commodity market in recent years and he's not driving the truck now.
The example is simplistic, but I think appropriate. If you don't buy into it, and fear that the biggest growth story the world has ever seen is going to stop because too many Americans have been flipping condos in Miami or because adjustable rate mortgages in Los Angeles are ticking time bombs that are going to take down the world economy, you may wish to abandon the resource sector. As one who views the natural resource sector as chronically challenged to deliver new discoveries and bring them to account, I lend little credence to the idea that the commodity cycle is over. If the Longer/Stronger model holds, we're not even halfway through the current Supercycle.
At this time of year, I do think that investors in the sector must be mindful of stocks that have traded much higher earlier this year. A good deal of rationalization-tax loss selling-will occur between now and year-end, with one result being that the last four months of 2006 can be expected to be more challenging than were the first four months of this year. That seems a given, and those with such matters to consider between now and year-end should be mindful of how quickly the market's psychology can change.
That being said, I see no evidence that the world's demand for resources is grinding to a halt, nor that the industry we're talking about is in any danger of delivering required new supplies of commodities any time soon. The less you buy into my reasoning, the more your portfolio should be reduced. The more apocalyptic your view of the global economy, the less exposure you should have to the resource sector, especially to the base metals side of the business.
© Copyright Gold Mining Stock Report 2006
Bob Bishop is Editor of Gold Mining Stock Report. Email for subscription info and samples of our service: info@goldminingstockreport.com |
