Precious Metals Sector Deal-making Padding Investor Wallets

By Mitchell Clark, B.Comm.

There have been a lot of mergers and acquisitions in the mining industry lately and the consolidation is only going to increase with gold over $1,800 an ounce and silver over $40.00. The buying and selling of entire companies adds to the attractiveness of the mining sector, with the bonus of a potential takeover of one of your holdings at a premium price.

According to Ernst & Young, which compiles a lot of research on the metal and mining industry, the first half of 2011 saw a total of 19 megadeals in the mining industry, each worth over a billion dollars. This is twice the number of deals compared to the first half of 2010 and the average transaction value has more than doubled. North American took the lead as the most attractive region for mergers and acquisitions. Ernst & Young cited that the average mining company debt is at an all-time low, while cash flow and profitability are at all-time highs. With good availability of capital and historically low debt levels across the sector, the firm expects robust third and fourth quarters for mining company mergers.

Precious metals is the one sector of the stock market in which I would consider taking on new positions with enthusiasm, even though as a group, share prices have already advanced significantly this year. We’ve seen this advance especially in smaller companies with established production. Small operations see their business model improve significantly when the spot price of the underlying commodity moves higher, largely because junior miners are typically unhedged. At $1,800 an ounce for gold, virtually any producer of the commodity is making money hand over fist as cash costs for production typically average around $500.00 an ounce.

There is a unique set of circumstances that have come together at the same time for precious metals (gold and silver in particular). A number of factors have contributed to the major move in spot prices. These include a declining U.S. dollar, the sovereign debt crisis in Europe, huge increases in the global money supply, interest rates at record lows, the U.S. sovereign debt downgrade, stagnant supplies of precious metals, and consistent demand for the commodities.

I think it will take some kind of catalyst for the spot price of gold to move above $2,000 an ounce and stay there. It’s likely that this catalyst will be related to sovereign debt, which is an issue that hasn’t gone away. All that’s happened so far is that European sovereign debt has been bailed out with another round of new debts. It’s a vicious cycle of debt that will probably be responsible for the breakup of the euro currency sometime this decade.

Accordingly, the fundamentals for gold (and silver) continue to be robust.

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