Big gold and silver miners have a problem: They’re evaporating. Each year they take more metal out of the ground than they discover, which brings them ever-closer to the end of the road. They know it and their shareholders know it, which means their stock prices tend to languish in the shadow of falling production and depressed future earnings.
The solution? Buy out junior miners sitting on resources big enough to arrest the majors’ decline. There aren’t that many such juniors, which points to a bidding war as the best are snapped up and the rest rise in sympathy.
Here’s an example that was announced a few hours ago:
Hecla Mining Company (NYSE:HL) and Klondex Mines (NYSE:KLDX; TSX:KDX) today announced Hecla will acquire all the outstanding shares of Klondex, a high-grade Nevada underground gold producer with its Fire Creek, Midas and Hollister mines, through a plan of arrangement. Klondex’s Canadian assets will be spun out to its existing shareholders.
Under the Transaction, Hecla will acquire Klondex for consideration of US$462 million with a mix of cash and shares of Hecla common stock and the newly formed company (Klondex Canada). Klondex’s shareholders will receive US$2.47 per share in cash or shares of Hecla, which represents a 59% premium to Klondex’s 30-day volume-weighted average price, as at March 16, 2018, on the NYSE American.
“Opportunities to acquire significant land packages along Nevada’s prolific gold trends are very rare. Rarer still are for these land packages to have the highest grade mines in the U.S. and this transaction is consistent with Hecla’s strategy of owning large prospective land packages with mines where we can improve costs, grow reserves and expand production,” said Phillips S. Baker, Jr., Hecla’s President and CEO. “We structured the deal to use our excess cash balances so our shareholders can benefit from the approximately 162,000 gold equivalent ounces a year of production while minimizing dilution.”
Terms of the Transaction
Klondex shareholders may elect to receive either US$2.47 in cash (Cash Alternative) or 0.6272 of a Hecla share (Share Alternative), each full Hecla share being currently valued at US$3.94, subject in each case to pro-ration based on a maximum cash consideration of US$157.4 million and a maximum number of Hecla shares issued of 77.4 million. If all Klondex shareholders elect either the Cash Alternative or the Share Alternative, each Klondex shareholder would be entitled to receive US$0.8411 in cash and 0.4136 Hecla shares. Klondex shareholders may also elect to receive US$0.8411 in cash and 0.4136 of a Hecla share and Klondex shareholders who fail to make an election will automatically receive US$0.8411 in cash and 0.4136 of a Hecla share. Klondex shareholders will also receive shares of a newly formed company (Klondex Canada) which will hold Klondex’s Canadian assets, including the True North and Bison Gold Resources properties.
To understand why more such deals are in the pipeline, here’s an analysis of gold’s reserve decline issue (or crisis as the writer puts it) from Canadian metals dealer Sprott Money:
For readers unfamiliar with mining fundamentals, in order for gold mining companies to be able to maintain steady, efficient production, they require (at least) several years of reserves of ore to process. These years of reserves are referred to as the “mine life” of that particular mining operation. Obviously mines (and companies) with more years of mine life in their reserves will be healthier than those with less years of reserves.
Between 2012 and 2013 alone, gold mine reserves across the industry plunged by almost 15% — a huge decline. Flash ahead three years, however, and mine reserves have continued their decline, uninterrupted. Last year was the fifth consecutive year of industry-wide declines in reserves. The cumulative effect of these years of declines? A report from AGF Investments on this subject calculates that current reserves reflect a 30-year low for the gold mining industry.
What happens when gold reserves steadily decline? Gold production begins to fall as well. Either some mines run out of reserves altogether and close, or mines simply reduce their production rate to reflect dwindling reserves. In 2016; gold mine production fell for the first time in a decade, and the expectation is for that decline to continue/worsen this year.
This supply crisis needs to be put into perspective through looking at demand. Gold imports into Asia (mostly China and India) continue at roughly 2,000 tonnes per year – often spiking to higher levels. Note, however, that China also produces more than 500 tonnes per year, with never a single ounce leaving the country. That accounts for roughly 2,500 tonnes of demand per year. Even with central bank gold purchases dropping off to a rate of ‘only’ about 300 tonnes per year, that accounts for almost all annual supply (currently about 3,100 tonnes).
This leaves virtually nothing for Western gold demand. Nothing for Western jewelry demand. Nothing for Western investment demand, to supply the sales of gold bars and coins from our national mints. This is a market in perpetual deficit (just like silver).
The only solution to this crisis is a higher gold price, a much higher price. With capital costs continuing to soar, making the decision to even begin construction of a new mine (and finance it) requires a much higher price of gold for most of the multi-million ounce gold deposits which are not currently in production.
This likely bodes well in the near term for those investing in junior gold mining companies, or planning to do so. However, it is yet another reason why investors in bullion can count on a rising price for gold over the medium term.
The calculus is pretty simple. Inadequate production leads to both higher precious metals prices and rising demand for exploitable reserves. So the juniors win twice, as the value of what they’re discovering and the desperation of the majors to buy them out both surge.
The problem with this dynamic is that it offers quick gains for the owners of high-quality junior miner shares at the cost of the spectacular profits that flow to a junior that’s allowed to grow into a mid-tier or major. In other words, that instant 50% capital gain pales next to the 1000% run that might be possible in the absence of a buy-out. But hey, in today’s world we should probably take our 50% profits where we can find them.
Which juniors are likely to be bought out for big premiums in the next few years? That’s hard to predict. But here are five candidates to consider (full disclosure: The DollarCollapse staff owns some of these and might acquire more over time):