Editorial: The Top Ten (January 03, 2007)

Every so often, a year is eventful enough to live up to its billing. In 2006, we saw some of the promised takeover battles that were supposed to enliven the previous five years; we saw some exciting discoveries, and some governments got greedy, as governments occasionally do. Herewith, a little retrospective on the year, counting down the ten biggest mining stories of 2006.

10. Barrick takes over Placer Dome. The year started with the endgame of Barrick Gold’s takeover of Placer Dome, armed with cash from Goldcorp. The Placer takeover, artfully done using mostly Barrick paper, made Barrick the biggest gold producer in the world.

Placer Dome seems to have had few mourners, having been regarded as a whole that didn’t quite equal the sum of its parts for the last few years. It was headed straight for the reefs, having counterposed a first-rate operational culture below decks with haphazard navigation topside. And sure enough, the deal that was finally done included a fistful of asset sales. So let it be with Placer.

9. The hollowing-out of Toronto. We purposely put this at the low end of the list because so much of the general and business press would put it near the top. After all, to lose two (reverent pause) Corporate Icons in what was effectively one takeover scrimmage is tragic, nay, apocalyptic. There can never, never be another Inco or Falconbridge. All is lost.

Oh, come on! In a takeover battle that resembled a circular firing squad, Companhia Vale do Rio Doce ended up with control of Inco and Xstrata control of Falconbridge. In 2005, Xstrata had already secured a 20% block in Falco (from those farsighted investors at Brascan who endured just enough of the trough in the resource industry to want nothing to do with the peak), and, in reaction, Falconbridge lined up Inco as a merger partner. But the fun only started in May 2006 with Xstrata’s and Teck Cominco’s closely timed takeover bids for the two Toronto companies.

Inco and Falconbridge responded by roping in an apparently dazed Phelps Dodge for a tripartite merger that didn’t survive Xstrata’s cash bid for Falconbridge, but did manage to announce to the world that Phelps had a vault full of cash and not much of a plan for it. Freeport McMoRan arrived late in November to clarify Phelps’s future, which is to be short.

Peter Munk, who presides over the board of Barrick Gold as a sort of philosopher-in-residence, afterward decried a lack of “balls…guts…vision” that kept executives at Inco, Falconbridge and Teck from creating a single Canadian mining behemoth — presumably one created to satisfy a Munkian corporate esthetic on Teck shareholders’ tab, which is nice work if you can get it — but we’d note two things. Inco and Falco shareholders made out like bandits. And almost all the mid-tier companies that will form the next cohort of international mining industry giants are domiciled, listed or managed in Canada.

But have the Inco and Falco shareholders missed out on a long-term resource renaissance? The early 20th-century financier Bernard Baruch is supposed to have said that he made his money “by selling too soon.” Falconbridge and Inco shareholders made good money the same way. We don’t call that a hollowing-out. And money can buy much more “vision” than anybody really needs.

8. Mongolia’s tax hacks. As the play clock ran out on 2006, the Constitutional Court in Mongolia overturned the country’s windfall tax on gold production, introduced in May. The court ruled the tax had no basis in law because it was based on a nonexistent price, the London Metal Exchange gold fix. (The LME trades base metals, not gold.)

Still, the country’s adoption of a windfall tax on copper production, a very poorly concealed play for a bigger piece of the revenue from Ivanhoe Mining’s Oyu Tolgoi copper deposit, flash-froze most of the Western-managed exploration projects in the country. Mongolia, which had worked hard on developing a reputation as a low-risk, high-potential place for mineral exploration, found its name take on negative value virtually overnight.

This does not seem to have deterred some legislators, who will return to work in 2007 with better-drafted plans for a windfall tax on gold, and an understanding of markets broadened not at all by contact with the facts. No doubt that as we speak, some functionary in the Mongolian civil service is writing, for the three-millionth time, “I will be more careful using the copy and paste function in MS-Word.”

7. The reddening risk map. Mongolia wasn’t alone in applying a discreet puff of capital repellent behind its ears. In July, the government of Uzbekistan seized gold and fixed assets at the Zarafshan joint venture, where Newmont Mining and two Uzbek state agencies were producing gold from tailings generated by the Muruntau gold mine. Uzbek tax authorities had declared the operation was US$48 million in arrears on taxes, based on changes to the country’s tax code. Newmont protested that the operation was subject to an agreement that insulated it from changes to the tax regime.

In Latin America, Venezuelan policies became increasingly erratic, which was not really news. Bolivia elected the government of Evo Morales, which promptly nationalized the natural gas industry (based in the politically hostile eastern states) and began toying with the idea of expropriating mineral properties after the conciliatory Walter Villaroel was forced from the Mines Minister’s job. Daniel Ortega, an ostensibly reformed Sandinista, was returned to the Nicaraguan presidency. Ecuador elected Rafael Correa, seen as a possible threat to the oil industry but not as an enemy of mining.

6. Aurelian’s big show. The discovery of the Fruta del Norte gold and silver deposit in the jungles of southeastern Ecuador puts up another candidate for the Big Discovery of the current metal price cycle. Analyst chat, which is a long way from a legally compliant resource estimate, puts the size of the discovery in the 10-million-oz. range and suggests the company is a takeover target.

The industry needs some very large and very good deposits to be discovered. We hope that, after a lot more drilling, Fruta will turn out to be one.

5. Aquiline vs. IMA. Another of the better discoveries of the cycle, the Navidad silver deposit in Argentina, changed hands after the Supreme Court of British Columbia ruled that IMA Exploration had staked the Navidad ground relying solely on information that Newmont Mining had provided to potential bidders for Newmont’s Calcatreu mineral property. Aquiline, the successful Calcatreu bidder, got the data set and sued for possession of Navidad, arguing that IMA had misused information that was only disclosed under a confidentiality agreement.

Between 2004 and 2006, Aquiline’s claim went from being “without merit,” to being worth $100,000 in “nuisance value,” to being worth $1 million and a block of shares, to a transfer of ownership. IMA is taking the decision to the B.C. Court of Appeal, where it is scheduled to be heard in April.

4. Gold prices. The last London gold fix of 2005 was US$513 per oz.; a year later it was US$635.70, having touched US$725 on the way. High gold prices are a friend to all gold producers, but none more so than the marginal operations. The strong gold price has allowed a new look at any number of projects that were considered risky at US$400 gold and impossible at US$300.

As well, the rising gold price solved a looming problem in the South African gold industry, still the world’s largest and most labour-intensive. For much of the last five years, the recovery in the gold price was more than matched by the rise of the South African rand against the United States dollar, squeezing margins at all but the most efficient South African mines. In 2004 and 2005, anywhere from 75% to 85% of South African mines were producing gold at negative operating margins.

With gold now around R4,400 per oz., most mines have a cushion of R1,000 per oz. or more, and secure jobs for South African miners could keep severe social dislocation at ba
y.

3. The Incredible Expanding Glamis Gold. Okay, so there is no more Glamis Gold, at least in the sense of a company’s name on an office door. But the creation of the newest of the majors, Goldcorp, through a US$8.6-billion takeover of Glamis, placed a heavy value on assets that Glamis acquired in earlier takeovers of Western Silver and Francisco Gold. (We pointed out in September that anyone who held Francisco shares in 2002 and tendered the Glamis shares from that transaction got 2.62 Goldcorp shares for one Francisco.)

Not everybody thought this wise for Goldcorp; there was an open split between management and a shareholder group led by former chairman Rob McEwen. But, as we have observed elsewhere, acquisition value generally works its way to the seller, and not the buyer. Kevin McArthur of Glamis, Randy Reifel of Francisco, and Thomas Patton and Dale Corman of Western Silver should be very, very popular with their former shareholders.

2. Uranium, again. Yellowcake prices closed out the year at US$72 per lb. U₃O₈, just about doubling over the course of the year. A commodity that, two years ago, had a few hardy survivors doing all the exploration now is the Street’s word for “buy me some.”

1. The body count. No, it wasn’t a headline, but the mining industry is facing a staffing crisis, one that spreads across professional, technical, and skilled-labour jobs. Through a long period of low commodity prices and assiduous cost-cutting, the industry sent a lot of people away; now it faces the task of bringing people back.

Trouble was, the industry’s bean-counters saw people as being a lot like tires. Now they are: you can’t get tires, either.