Gold's rise fuelling M&A fever


So much for psychological barriers.

The price of gold topped $700 (U.S.) an ounce Tuesday for the first time in almost three decades. Like in 1980, a standoff between the U.S. and Iran helped fuel the precious metal's ride, as gold prices built on an almost 40-per-cent gain since the end of last year.

But while gold may be heavily influenced by concern over Iran's possible development of nuclear weapons, it's having the greatest impact on mining companies, many of which based their financial estimates for coming quarters on gold in the mid-$500 range.

Flush with cash and finding it increasingly difficult to develop new supply sources, gold producers are on an acquisition frenzy that could change the face of the industry.

In 2005, the combined value of gold deals in Canada was about $16.6-billion (Canadian), according to Ed Giacomelli, managing director of Toronto-based investment banker Crosbie & Co., up from $3.3-billion the year before. Given current prices, Mr. Giacomelli expects the level of activity to be just as intense in the sector this year as it was last.

“In a market like this, the reality is deals can get done,” he said.

Thanks to soaring prices, gold producers are producing record levels of cash flow. But those high prices are also making gold-producer equity more attractive. Therefore, gold companies are in a much better position to use cash and equity to make a purchase, Mr. Giacomelli said.

Gold stocks have historically traded at premium valuations because of their scarcity relative to investor demand, UBS Securities Canada Inc. analyst Tony Lesiak said in a recent report. Gold producers also have the added benefit of leverage, meaning they are able to record greater gains than the increase in gold's market price.

Translating higher gold prices into higher profit isn't so clear cut for many mining companies, however. For one thing, pulling gold out of the ground is an energy-intensive process, and energy prices are high. Canadian producers have also been hit hard by currency costs. While gold futures have surged 160 per cent over the past five years, the price in Canadian dollar terms has only increased 121 per cent. Many companies also pay employees in local currencies, adding more cost uncertainty.

But with gold at multidecade highs, almost every producer with cash to spare is on the prowl for acquisitions. The Canadian sector has already seen its share of blockbuster deals, including Barrick Gold Corp.'s $10-billion (U.S.) takeover of Placer Dome Inc. With some analysts predicting gold could break through the record price of $850 by the end of the year, the pace of acquisitions is likely to pick up.

Gold, which traditionally has an inverse price relationship to the U.S. dollar, is also soaring at a time when the greenback is hitting its lowest level in a year against some of the world's currencies.

There's increasing expectation that countries such as China and Russia are looking to diversify their reserves from U.S. dollars, according to Patricia Mohr, vice-president of Scotia Economics. Gold may be the commodity of choice to replenish those reserves, she added, meaning further upside for the precious metal and downside for the greenback.

However, in a white-hot commodities market, a 40-per-cent price increase since the end of last year barely places gold among the front-runners. Squeezed by tight supply and soaring demand from nations such as China, the price of many base metals have reached record highs. Copper, for example, has increased in price more than 70 per cent this year.

Even silver, which trades on many of the same fundamentals as gold, has outperformed the precious metal this year, jumping 67 per cent. The increase is mainly due to the introduction of a silver exchange traded fund, which is expected to attract massive investor interest.

Still, the market doesn't seem to believe the precious metals rally is due for a correction any time soon.

“I don't think they've peaked,” Ms. Mohr said. “I think there's still some upside this year.”