Gold mining requires larger nuggets

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The great gold roll-up has been a long time coming. Deals in the space might have been attractive, such as Newmont’s $19 billion bid for Newcrest last year, but they are best characterized as a filter. AngloGold Ashanti’s £1.9bn bid for UK-listed Centamin is a sign that pressure for consolidation is mounting.

The US-listed miner is taking advantage of its bright share price run to get a reasonable deal. At yesterday’s close, Anglo shares were up nearly 60% year-to-date, compared with Centamin’s 20% gain. That means it can afford to offer a hefty 37% premium and still value Centamin at just 3.9 times this year’s ebitda, on Morgan Stanley’s numbers, compared with its own 4.5 times. Synergies have been suggested rather than quantified: there will be some savings in headquarters and procurement. It may also be able to make more of Centamin’s star asset, the low-cost Sukari gold mine in Egypt, given its larger balance sheet and operational capabilities.

Investors should expect more from this type of opportunistic offering. The gold sector needs consolidation. It is fragmented, with dozens of companies in the $1 billion-plus market cap range. In addition, underinvestment in exploration has led to a lack of new projects, and companies are increasingly eager to source each other’s resources.

Animal spirits will be delighted by the valuation differences that have opened up in the sector. AngloGold is a prime example. But while miners’ performance was generally disappointing compared to the commodity, larger groups fared better than their junior rivals. The GDX index, which tracks mainly gold and silver miners, has risen 34% over the past five years, twice as much as the GDXJ, which tracks smaller operators. While there are many exceptions to this general rule, it fits the broader trend of mid-caps struggling to compete for investor dollars.

The ongoing gold market could accelerate this process. US equity market flows should divert flows to the sector. And larger companies are likely to capture more than their fair share of this generalist money than the multitude of smaller, riskier operators. Name recognition and coverage of the analyst play an important role. But gold at $2,500 an ounce means (for once) producing companies, which have average cash costs of about $1,950 an ounce, according to BMO’s Raj Ray, are also in a position to offer reasonable returns .

As it regains its luster in the eyes of investors, they will be in a better position to look for sector nuggets.

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