Perils Of Gold Stocks

One of the argments for rising gold prices - diminishing production, or so-called "peak gold" - doesn't bode well for gold stocks. This article by Kishori Krishnan, entitled "Gold Industry On Final Deathwatch?", goes into the production difficulties some gold-mining companies are facing. She makes the useful point that the hoped-for leverage from gold stocks is not automatic, particularly nowadays. The easy deposits have been found, and some mining companies are in conservation mode.


Jim Puplava of the Financial Sense Newshour podcast has pointed out that there's one way for the majors to compensate: buying junior-gold companies with feasible "elephant" deposits, or ones that have at least a million ounces of gold (probably, several million.) He predicted that 2010 will be the year of mergers and acquisitions in the junior-gold sector.

His prediction makes sense for two reasons: first of all, financing is harder to come by for juniors. Secondly, M & A activity, in general, increases some time after production has peaked. The trusts came into their own in the middle of the original Great Depression (1873-1896.) M & A activity ballooned in the 1980s, about a decade after the U.S. economy began spluttering. Consolidation makes sense in those times for two reasons: prospects for direct expansion don't look that encouraging, and existing companies's prices have been beaten down (because of pessimism) to bargains. A study of the M&A trend, done about twenty years ago, revealed that the only acquisitions which made business sense were of companies whose assets were bought at a significant discount. A funny conclusion in a way, as it implied that a good corporate acquirer uses the same rule that good value investors follow.

Since the coin of the realm is "assets at a discount," it follows that a takeover-candiate junior has to have a market cap that values its gold reserves at an enticingly low price. These companies were easy to find a year ago, but not so much now. Also: Puplava's criterion has to be kept in mind. Unless the property's reserves show a solid seven figures' worth of gold in ounces, it's beneath an acquirer's notice.