Ryan McIntyre is a Portfolio Manager of Sprott Hathaway Special Situations Strategy and a Portfolio Manager at Tocqueville Asset Management L.P. Sprott and Tocqueville joined together in early 2019 to offer investors a strategy that capitalizes on the combined strengths of two gold-investing industry leaders.
The gold mining sector appears to have turned over a new leaf. It is reshaping itself to generate higher returns on capital even in a neutral gold price environment. Over the past nine months, we have seen some notable value creating activity in the gold mining sector. The first significant move was the merger between Barrick Gold Corporation (Barrick) and Randgold Resources Limited (Randgold) to form, at the time, the largest gold mining company in the world.
The Barrick-Randgold merger was announced in September 2018 and there was no premium paid, which is unique. The merger's success relies solely on the synergies of the combined companies. Barrick contributed via its high-quality, diversified asset base and Randgold brought its high-quality asset base, focused management and disciplined capital allocation framework. The market reaction was positive and Barrick outperformed the benchmark (i.e., the Philadelphia Gold and Silver Index [XAU]) by 26% from the time of the announcement to the close of the merger on January 1, 2019.
Figure 1. Barrick Price Performance from Merger Announcement to Close
September 18, 2018 - January 1, 2019
Barrick quickly followed this up in March 2019 by announcing a joint venture with Newmont Mining Corporation (Newmont) to combine its operations in Nevada. The net present value of the pre-tax synergies expected from the Nevada joint venture is estimated to be $5 billion. Astonishingly, despite the significant synergies, a combination of the Nevada operations between the companies had been talked about for many years but was never consummated. It illustrates that conditions in the sector today are such that shareholders demand value creation and will no longer accept excuses that inhibit the obvious.
Figure 2 lists several recent notable value creating initiatives in the sector. What these examples consistently show is that the industry is helping itself and not waiting for external factors (e.g., gold price) to improve. Ironically, these activities are likely to improve the prospects for the gold price.
Source: Tocqueville Asset Management.
The gold price and capital markets are forcing discipline and the companies are reacting. Meetings with almost all of our portfolio companies in the past four months indicate serious intent by management to align decision making with shareholder interests. Some of the conversations have already yielded positive outcomes. Today, little money is spent on exploration, development or optimization without a high probability of a positive outcome. Investors are taking an increasingly active role in the mining sector.
According to Kingsdale Advisors, there have been 13 activist campaigns over the past 26 months in the gold sector.1 More interestingly, the vast majority of activist campaigns have been successful, as shown in Figure 3. In December 2018, as noted in Figure 2, shareholders of Detour Gold voted to remove the majority of the Board. Shareholders (including Tocqueville) felt that there was not enough focus on its only mine and that the Board needed to be revitalized to ensure a higher probability of success.
Figure 3. Gold Sector: Proxy Outcomes (2017-2019)
Source: Kingsdale Advisors.
A few companies in the gold mining sector are developing new technologies and systems that could reduce costs and increase productivity. For example, Torex Gold Resources Inc. (Torex) is currently testing a new proprietary underground mining technology/system called Muckahi.
Muckahi is a new underground process and set of equipment that aims to reduce the size of the tunnels and increase productivity. Muckahi was developed by Torex’s in-house team that has substantial underground experience. If the testing in 2019 is successful, it will lower costs and timing for all things underground (i.e., exploration, development and mining) for many different deposits around the world.
Torex could leverage the Muckahi technology at its own Media Luna project in Mexico, and by acquiring marginal or historic mines in good jurisdictions at a low cost and implementing Muckahi. Overall, Muckahi could be game changing for Torex and the mining industry by improving returns at static commodity prices. The probability of success is reasonable and the reward, if successful, is exceptionally high with a low cost of failure. This is exactly the type of investment that shareholders should desire.
These types of "intrinsic" value creating activities are likely to continue across the gold mining industry. Both large and small companies are examining many alternatives to add value independently of the gold price, which is (and has always been) Tocqueville’s focus in stock selection. The value enhancements we are likely to see involve management teams using their core competencies to unlock value in existing mines or new projects. Mergers and acquisitions will feature prominently in this as assets are rationalized and skills are transferred. Overall, the allocation of capital is being improved by disciplined management who minimize risk and require a reasonable rate of return. All of this will inevitably slow production growth, which should result in the industry being more profitable.
We believe that Tocqueville’s portfolios are well positioned to take advantage of the current situation given our involvement with high-quality management teams and mines/projects. Additionally, because all but a few equity investors have abandoned this sector, we are seeing many more opportunities to get involved on very attractive financial terms as well as having significant inputs into shaping strategy. Our portfolios are focused on companies that are adding value as opposed to betting on higher gold prices. Therefore, we are biased toward smaller- to mid-cap companies that are more likely to be engaged in value additive activities such as exploration, or development, production expansion/optimization and be sought after in mergers and acquisitions. It also means that we are shunning the "closet indexing" game to mimic ETFs and widely followed indices.
This report is reprinted with permission from Tocqueville Asset Management. © Tocqueville Asset Management L.P., June 19, 2019
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