"Enormous Consolidation" Expected In Gold Mining In 2012

By Justin Dove, Investment U Research

In late September, Dr. Mark Skousen wrote about why the gold mining sector was lagging after a major run by the precious metal.

He cited precious metals' expert Rick Rule on the five reasons the sector was currently struggling and then four reasons why it was due for a major rebound. Of those four reasons, number two and three especially stand out:

"2. Top mining companies are finally generating dramatically higher profit margins. Free cash flow is now "gushing" and will double in the next year as huge capital investments by the majors pay off.

"3. Expect enormous consolidation as majors start buying up smaller producers, at startling premiums to current market prices."

Now that we're in November, we're starting to see strong evidence of this beginning to happen.

"Massive" Industry Consolidation to Continue

According to Global Mining Finance, "Mining M&As accounted for five percent of the total deals done this year, a figure not seen since the heady days of 2006." And Bloomberg data found that gold takeovers in the second quarter, valued at $20 billion, was the most in at least 10 years.

Ernst & Young reported in October that during the nine months of 2011, there were 779 M&A transactions with a value of $132 billion. That's a 67-percent increase over first nine months of 2010!

And even more is expected through 2013...

Bloomberg recently reported that BlackRock Inc., "which manages $36 billion in natural resources funds, expects the 'massive' industry consolidation in mining to continue, driven by low valuations of companies."

The article also cites a report by Standard Chartered, which predicts the six largest miners will have collectively amassed $144 billion in cash by the end of 2013.

"You've got falling earnings, you've got compressed multiples, most of mining companies are trading under replacement costs," Pengana Global Resources Fund's Ric Ronge told Bloomberg. "There are definitely opportunities. The market is pretty much ripe for consolidation."

Bottom Line

The persistence of Europe's problems, increasing possibilities of more money-printing and growing demand from Asia should keep margins quite high for miners. This should start to majorly affect the bottom lines of these companies in 2012 and beyond.

Keep an eye on mid-sized and junior mining companies with strong newer projects that may be attractive to the bigger mining companies. When older mines start to dry out, these companies will need to find fresher ones. With large injections of cash and relatively low valuations on mining companies, the easiest way may be to buy up a smaller operation.

Good investing,

Justin Dove