Fantasy Girl Revist - Google Googlplexed

In the fall I was writing my blog over on Stockhouse and I wrote this 10 part series which I titled Fantasy Girl and a subtitle for each post. Half the posts were taking detailed look at why Google's earnings would not keep up, as in the news story Google's Profit Falls Short, Shares Drop. The other half were looking at Goldcorp and the serious valuation problems with that one for investors. Those parts I worked on polishing up further and turned it into my post, How I Discovered the Gold Bubble.

For the Google related part of the series I intended my posts to show how when growth rates are unreasonable large applying that PEG dogma is nonsense by starting with an absurd rate of interest and hoped people would make the connected that their expectations from Google were also absurd.

I like Google's products and services and use the all the time, however, when too many people get on a boat it sinks. Here's my original analysis of Google from November 2006.

Fantasy Girl - Up 10,000,000,000 % Part I

Have you ever had a day where you could say you were up 10,000,000,000%?

Are you sure?

Just what kind of daily percent would you have to make each trading day to make 10,000,000,000% in a year?


Compounding interest is a wonderful thing. I do this math thing where my spreadsheet calculates my percent change for the day, and my annualize change if I did that percent each of the 240 trading days of the year.

The formula if you let D be your day's earnings, O be your day's open is:

Annualized rate of return = (1 + D/O)^240 - 1

The D/O gives you your percent increase for the day, and taking it to the power of 240 compounds it much the same way you might to a simply compounding interest calculation for 10 years.

So, what percent?

Well, I found out yesterday, and wow, what a lesson on compounding interest. 10 billion percent it said, and I went to correct my error, only there wasn't an error. At that point my portfolio was up 8%, and wow, the annualized rate of return if you could do that everyday is 10 billion percent! And a different stock, with a small holding, went up, so I changed it, and wow, up 13 billion %, and up more, and then 33 billion %.

But wait, that's not a lot of extra dollars causing that jump. Huh? I looked at the percents, 8.1% gets you 13 billion, and 8.5% gets you 33 billion, and well, 10.1% gets you over a trillion %.

In absolute terms, the increases are small compared to compounding effects. By comparison, to go from 0%, to 0.1%, the same absolute difference, as 8% to 8.1% the annualized rate goes from zero to 27%, a small percentage difference compared to from 10 billion to 13 billion %.

And herein lies part of the problem in how we can get ourselves into enormous trouble with our portfolio when past growth rates of a company are used to project future valuation. The bigger the growth, the company experienced, ie, already had, the harder it is to ever meet that crazy expectation.

In the next few posts I'll examine the financial difference between using past growth numbers and future growth numbers, and how some of the those past growth numbers are setting investors up for financial ruin.


Fantasy Girl - 300 Billion! Part II

The main idea from the first post in the first Fantasy Girl series was that as the rate gets higher, the magnitude of the difference in compounding increases dramatically with tiny increases in the rate use. The two examples have a mere 0.1% difference in rate. Compounded rate = (1 + daily rate)^240 - 1

	Daily rate	Compounded rate
A	8%	10,000,000,000%
B	8.1%	13,000,000,000%
B minus A	0.1%	3,000,000,000%
C	0.0%	0%
D	0.1%	27%
D minus C	0.1%	27%

The tiny increase in rate in these two examples is 0.1%, but the absolute difference becomes unimaginable as the rate gets absurd.

But, what would happen if you did that 0.1% per trading day for say, 12 years?

Year	Total interest
0	0%
1	27%
2	62%
3	105%
4	161%
5	232%
6	322%
7	436%
8	581%
9	766%
10	1001%
11	1299%
12	1679%

Well, if you started with $10,000, in 12 years you'd have $177,88, and $167,880 of "wealth" has been created.

But, just how did that wealth get created?

There are many paths to that wealth. Some will create wealth that will be sustainable, and some could be described as lying in wait for nuclear melt down.

How about taking a look at say ... Google (GOOG), and later, a much smaller company.

Google's market cap is $153 billion dollars. Google's share price is up about 33% in two months. About $38 billion dollars of market cap.

And just what is the annualized rate of growth if you increase by 1/3rd in 3 months?

(1.33^6 -1) = 213%

Oh boy, if we keep going like this, we should see $1100/share by next summer and a market of $300 billion. What a great company... And wow, this company is everywhere, it can do anything...

But....

Part III a closer look at what Google's financials are saying...


Fantasy Girl - Googlplex 10^100^10 - Part III

Googolplex - 1 followed by a googol of zeros

Recap:

• As growth rates increase even marginally, they have exceptionally larger effect on the end numbers.
• Google has a market cap of $153 billion and its share price is up 33% in two months, creating $38 billion of market cap.
• To continue at the current growth rate, Google would be up 210% by the end of the year.
  

Oct 19, 2006
EXTRA, EXTRA READ ALL ABOUT IT
Google Revenues increase 70%

The PEG Ratio says that if price/earning is less than the growth rate, you've got an undervalued stock, although the Motley Fool suggests it should be 0.5 or less to be undervalued (http://www.fool.com/Pegulator/pegulator.htm). For correct use, the PEG is dependent on an expectation of 5 years of growth at the rate used for the earnings per share.

So, just what have Google's earnings per share been?

Quarter	Earnings/ share	1% increase over last Quarter	2Annualized Quarter Growth	3Annual Growth to Q1/05
Q1 2005	1.29	n/a	n/a	n/a
Q2 2005	1.19	-7.8%	-27.6%	-27.6%
Q3 2005	1.32	10.9%	51%	4.7%
Q4 2005	1.22	-5.5%	-20%	-7.2%
Q1 2006	1.95	59.8%	553%	51%
Q2 2006	2.33	19.5%	104%	48%
Q3 2006	2.36	1.2%	5.3%	41%

1This is a quarterly rate of return (loss). 2The rate must be taken to the 4th power to get the annualized rate. 3This is what the rate of return is if it was constant back to Q1 2005.

The headline said 70% growth, where is it in the earnings?

Seriously, time to apply the PEG ratio, using the 5 year standard that it was based on. So, being optimistic, lets say that overall annual rate of 41% will be continue over the next 5 years. Keep in mind that a 41% annual growth rate means we are looking for 1.41^5-1 = 457% over the next five years. If you don't appreciate why we are looking at 457% growth over the next 5 years, go back and read www.stockhouse.ca/blogs.asp?page=viewpost&blogID=459&postID=6959.

So P/E = $505/(2.36+2.33+1.95+1.22) = 64.2

Hmmm, 64.2 is not less than 41. 457% of sales growth over the next 5 years will not be enough. 64.2/41 = 1.56

Double hmmmm. At 1 - 1.3 the Motley fool is saying a stock is overvalued. At 1.7, it is saying short!

But, there is something even more serious to notice here, the gross rapid decline in the quarterly growth rate in 2006. The decline in that growth rate is like a nuclear melt down.

And seriously, 1.642^5-1 = 1094%. To force the PEG to be one, we need 1094% in growth of earnings over the next 5 years. And that's for the current share price to catch up to itself, without growing at this absurd rate of 450% per year. We need even more growth in real sales and real wealth if the stock continues to create market cap out of thin air.

But, given this, I predict the next headline will read an even great rate of growth. Next post I'll explain how the numbers can be used to show this, and I'll even predict when the nuclear meltdown will occur.

And even more seriously, earnings per share are 1.6% of the share price. You can do better in the bank and your money is safe.

Fantasy Girl - Googlplex^Googlplex - Part IV

Googol - 10^100

This is the 4th post in a series on valuation and growth when growth rates are big.

Recap

• Google's 2 month growth rate on share price ($380->$505) is 210% annualized.
• Correct use of PEG says earning must be expected to increase by 1094% in the next 5 years without any further increase in share price.
  
• Quarterly data on earnings per share show dramatic declines in growth.
  

Perceptions of Growth - Google's Next Quarterly Report

The last quarterly headline read "Revenue Up 70%." And the next report will probably read something like "Earnings up 90%." Remember the 3 billion percent difference in annualize return between 8 and 8.1% from part 1? Yet it didn't seem so extreme using 0% and 0.1%. A large past growth rate easily hides rapidly declining growth. Here's how.

First, we need to look at earnings per share and increases in earnings per share over the previous quarter, and the quarter one year ago.

Quarter	Earnings/ share	% increase over last Quarter	% increase over Quarter 1 year earlier	Quarter increase annualized
Q4 2004	0.71	n/a	n/a	n/a
Q1 2005	1.29	82%	n/a	997%
Q2 2005	1.19	-7.8%	n/a	-28%
Q3 2005	1.32	10.9%	n/a	51%
Q4 2005	1.22	-5.5%	72%	-20%
Q1 2006	1.95	59.8%	51%	552%
Q2 2006	2.33	19.5%	96%	104%
Q3 2006	2.36	1.3%	78%	5.3%

If you just compared Q3-06 to Q3-05, you'd see a 78% growth in earnings, and that's exceptional. But, where in the news was the headline:

Google's Growth in Q3 Earnings Decline by 94%

(1-1.3/19.5) * 100% = 94%

We are playing with exponential growth here, so it is fundamentally important to consider the exponential growth consequences.

But, lets look at how the headlines will read for Q4, based on 3 projections I got from MarketWatch, a low estimate of $2.31, a mean of $2.72, and a high of $3.13. Notice earnings in Q4 2005 were down. That's going to be great for punching the numbers to make things look good... Might even be able to get away with increasing projections to $1000 per share!

Q4 2006 Estimate	% increase over $1.22	% increase over $2.36	Annualized Growth Rate	PEG = one @
2.31	89%	-2.1%	-8.2%	$795
2.72	123%	15.3%	76.5%	$1150
3.13	156%	32.6%	209%	$1500

So, there you have it, the next headline:

Q4 - Google's Earnings up 89%

And the red elephant hides in plain view. PEG wrongly used supports share prices at a low of $800 and a high of $1500, creating an additional $90 to 300 Billion in market cap, out of thin air. I need one of these money trees in my back yard.

But what of Q1 - 2007? Notice that jump from $1.22 to $1.95 between Q4 and Q1? That's going to play havoc with the numbers. MarketWatch estimates are a low of $2.10, a mean of $2.98 and a high of $3.28

Q1 2007 Estimate	% up over $1.95	% up over $2.31	% up over $2.72	% up over $3.13	Annualized Rate Over $2.32	Annualized Rate Over $2.72	Annualized Rate Over $3.13	PEG = one @
$2.10	7.7%	-9.1%	-23%	-33%	-32%,	-65%	-80%	$73
$2.98	53%	29%	9.6%	-4.8%	176%	44%	-18%	$550
$3.28	68%	42%	20.6%	4.8%	307%	111%	21%	$725

There's a lot more red elephants in that chart, and the growth over the same quarter in the previous year is much smaller than what Q4 projects. I predict there's going to be a lot of pain right about here.

One more thing, that by looking at the PEG calculation between three estimates and 2 quarters and finding a share price valuation that varies by a magnitude of TWENTY ($73 vs $1500) simply says the PEG is grossly misused and is best left for Voo Doo economics.

Part V, a different kind of valuation...

Fantasy Girl - Scrooged - Part V

"But you were always a good man of business, Jacob." Ebenezer Scrooge

Recap

• Google's market cap: $153 billion, $38 billion created in past two month.
• Q4 PEG could support $800-$1500 share price, creating up to $300 billion more market cap.
  
• Q1/07 PEG could suggest a share price as low as $73, destroying $130 billion in market cap.
• Oops, easy come, easy go, $6 billion of market cap gone today 11/27/06.
  

How does your bank treat you?

Ultimately, sound investment is about a company's ability to generate earnings relative to the investment. Sure, there is tons of money to be made on greed, fear, and speculation, but that isn't realistic or fair valuation.

Your bank:

• Wants security for 6%
• Good credit rating for 10%
  
• Has legal recourse against you
  

Google, earnings per share from the last 4 quarters comes to a mere 1.6% of share price, you have no legal recourse and you are risking your savings. By banking standards, for fully secured, earnings per share needs to be in the $30/share range $7.50 per quarter at the very minimum. Currently, Google's earnings per share aren't even keeping up with the rate of inflation!

So, just how much do you expect Google to grow to reach market staturation? At some point all companies reach maturity and have limited growth prospects. Where is that for Google, and how many years?

Say the company grows to earnings of $50 per share in 10 years to reach market maturity, and at that point because Google is a big secure company, that's about where earnings will stay. This is a highly optimistic quarterly growth rate for earnings of 4.3%.

Lets examine 3 examples:

1. You want 6% return on your money and you are confident Google can to it.
2. For that kind of speculation, you want 10% return on your investment today.
3. You think growing to earnings of $50/share is highly unlikely, and you want 15% because of the high risk you are taking because it is highly unlikely.
   

For $50/share earnings to be 6%, the share price would be $833.

% return wanted (r)	(1+r)^10	Present Value of Shares
6%	1.79	$465
10%	2.59	$321
15%	4.04	$206

So, with a low expectation of return (6%), and highly optimistic growth projections (>400%), a fair share prices would be $465. But wouldn't bonds be safer?

With a 10% expected rate of return, and a highly optimistic growth projection, $321 would be a fair share price.

And finally, if you don't think it is likely, and want 15% return because of the high risk of not making it, $206 is a fair share price.

Some created wealth is sustainable, but some is simply waiting for nuclear melt down. So Barrons called Google richly valued today.

Can we say Google Bubble?

Next a little gold dust fantasy.

www.forbes.com/2002/09/13/400fictional_5.html

Read More......

Yamana, Northern Orion, and Meridian Gold Merger

Northern Orion first got my attention last fall when it was trading at about $4 Canadian at the beginning of October 2006, and given its under valuation, the upward march in October made sense. Then it gradually declined, again touching just under the $4 mark at the beginning of January.

It was during that descent that I started to contrast how it was being valued relatively in the market to ensure my perspective was reasonable and because of the joint ownership of the Alumbrera mine, Goldcorp was the most logical company to contrast relative valuations. The result was How I discovered the Gold Bubble and I came to the conclusion that Northern OrionLoading... was a buy to $7 based on its property holdings.

Wednesday’s joint news release announces a proposal to merger between Yamana Gold, and Northern OrionLoading... with an offer for Meridian Gold to be a part of the deal. The effective price for Northern OrionLoading... is $7.07 per share, a 21.3% premium over the day’s closing price, the same valuation that I came up with for Northern OrionLoading... without development of the Auga Rica property.

Northern Orion also has two types of warrants. The regular warrant holders closed at $4/share on Wednesday, so with an exercise price of $2, they have a 27% premium on the close, and still have until May 29, 2008 to exercise their warrants. The A warrants were not “in the money” warrants. They are exercisable until February 17, 2010. If Northern Orion managed to get their Auga Rica property developed in time for the A warrants, the roughly 600% growth in production meant that those out of the money warrants had a potentially very nice risk-reward ratio. The A warrants transfer to buy 0.543 of a Yamana share for $6. It means that Yamana’s share value must increase to $14.42, or $1.40 over the $13.02 close, in order for the A warrants to be in the money at their $1.83 price. Without this offer Northern Orion’s share price would have to increase $2 to $7.83 for the A warrants to be in the money. Relatively speaking, before the deal Northern Orion’s shares had to increase 34% to break even and at the time of the press release Yamana’s shares have to increase by 11% to break even.

But, that was before today’s Yamana’s share price declined. With the decline to $11.83 the take-over price works out to $6.42 for Northern Orion, and for the A warrants the Yamana share price needs to increase 23% to $14.54 to be in the money from today’s $1.90 close.

Before any merger fully diluted Yamana Gold has 381.9 million shares. The merge adds 309.4 million shares for shares and if all Northern Orion warrants and options were exercised, another 37.5 million. A real plus for Meridan Gold is they state they’ve only had 36% stock dilution compared to an average of 417% among their peers since 2000. There appears to be only an extra 820,830 options, so very little dilution. If all options were exercised there would be an additional 1.8 million shares, for a total of 730.6 million shares. Going with Wednesday’s close of $13.02, that would give a fully diluted market cap of $9.5 billion, which has declined to $8.6 billion with today’s price decline.

Production

So, putting together the total of the three company’s production, and you have:

Northern Orion

• Alumbrera, Argentina, about 50 million pounds of copper, 75,000 oz gold

Northern Orion can expect about $160 million of gross revenue, Q1 gross sales were $34.8 million. The royalty that kicked last year is costing 96c/lb of copper for Q1.

Meridian Gold

• Rossi/Storm JV, Nevada, 25,000 oz gold for 2007, 30-40,000 oz for 2008
• El Penon, Chili, 230,000 oz gold, 6 million oz silver
• Minera Florida, Chili, 70,000 oz gold
• Zinc production, 8 million pounds, my estimate from Q1 financial report

Meridian Gold can expect about $300 million gross revenue, Q1 gross sales were $66.4 million.
Yamana

• 600,000 oz gold, 140 million pounds of copper.

Yamana can expect about $840 million gross revenue, Q1’s gross were $145.1 million.
Combined production is about 1 million ounces gold, 6 million ounces silver, 8 million pounds zinc and 190 million pounds of copper. At $650/oz for gold, $12.50/oz for silver, $1.50/lb for zinc and $3.20/lb for copper it gives about $1.3 billion in gross sales without hedges.
Q1 earnings were $27.4 million for Yamana, $9.5 million for Northern Orion, and $18.9 million for Meridian Gold, or $55.8 million.
Quality of Reserves
Grade quality of reserves and resources must also be considered.
Yamana
At December 2006 Yamana had 6.9 million ounces of gold at 0.49 g/ton, or metal values of $10/ton. Additionally there is 2.3 billion pounds of copper at 0.35% or about $25/ton. As some of the copper metal values overlap with the gold, weighted average metal values of copper and gold combined work out to $28/ton. The 13.7 million ounce of gold and 2.8 billion pounds of copper in the mineral resource has smaller average metal values, about $23/ton.
If you could master 100% recovery, at these grades you need to mine over 63 tonnes of ore to produce a single ounce of gold with 0.49 g/ton. Chances are they have higher grade veins to mine first, but the sheer magnitude of the amount of ore per ounce of gold suggests high production costs, or grossly increasing production costs as the grade mined declines.
To put it into perspective, the Chapada property has both the copper and gold and its metal values work out to $37/ton in the proven reserves and $30/ton in the probable reserves, essentially a 20% decline in metal values as the mine life proceeds and they move from mining the proven reserves to the probable reserves. At 0.34 g/ton 92 tonnes of ore must be mined for an ounce of gold. Take the grade down to the 0.26 g/ton and you need 120 tonnes of ore. Compounding this problem is that recovery rates also tend to decline as the grade declines, so where you might have had 90% recovery, you now have 80 or 85% recovery, the 92 tonnes required becomes 102 tonnes required at 90% recovery and the 120 tonnes required becomes 142 tonnes at 85% recovery.
You can take copper production and take those dollars and apply them to gold production and give the appearance of low cost gold production, but what you’ve essentially done is allow copper production to trade at gold multiples. With Q1/07 dilute earnings of 7c/share multiplied forward by 4 quarters you get 28c/share. That gives a P/E of 46, so copper sales are trading at a P/E multiple of 46.
Looking further, for Q1 the Chapada mine produced 38,954 oz gold and 27.5 million pounds of copper. That is about 32% of the gold production. Chapada was responsible for 60.6% of the net revenue, which leveraged to 87.4% of the operating earnings. That detail screams that the other mines are not making much money. For Q1 the grade mined at Chapada was 0.57 g/ton gold and 0.47% copper, the metal values per tonne mined were $45/ton, way more than the $37/ton metal values for the remainder of the proven reserves, and the $30/ton of the probable reserves.
Northern Orion
Alumbrera has a life of mine until 2016 and has 0.45% copper, 0.014% molybdenum and 0.47g/ton of gold for metal values of about $51/ton. Alumbrera has a 20% royalty that kicked in last year.
Agua Rica has reserves of 0.50% copper, 0.033% molybdenum and 0.23g/ton gold for metal values of about $61/ton. The Agua reserve has 8 billion pounds contained copper, 531 million pounds molybdenum and 5.4 million ounces of gold.
Meridian Gold
Meridian’s El Penon is stellar, 6.6 g/ton of gold and 275 g/ton of silver in the proven and probable reserves. At $640/oz for gold and $12/oz for silver, that’s a very nice $242/ton in metal values.
Minera Florida has 1.5% zinc, 27 g/ton silver and 5.3 g/ton gold for $169/ton metal values.
Rossi has a resource grade of 15.4 g/ton of gold for $317/ton, but the deposit is very small.
Esquel is has a stellar grade of 23g/ton of silver and 15g/ton of gold for $317/ton.
Of the three, Meridian Gold has the smallest reserve/resource contribution, but it has more profitable grades, even for the more costly underground mining.
The Growth Profile
Checking out their presentation, the two-year plan is to move from 1 million ounces of production this year to 1.5 million ounce by 2009, or a 50% increase in gold production. Say gold is $650/oz, that’s an extra $325 million/year of gross revenue. A move from 1 million ounces to 1.5 million ounces would only increase the gross revenue by about 25% as about half the revenue is from the zinc, copper and silver. There may be plans to increase production of these metals, but that information was not included in their presentation.
The increased production plan does not include developing Agua Rica, or Esquel. Agua Rica has a feasibility study to produce 365 million pounds of copper, 125,000 oz of gold and 16 million pounds of molybdenum. Say copper was $2/lb and molybdenum was $15/lb and gold $700/oz, that would give $1 billion of gross revenue. There would be no outrageous 96c/lb royalty on this production. There could also be the option of partnering with Alumbrera for some other kind of production arrangements as they are close together.
Conclusion
Just because you label a company a gold producer or a base metal producer is not justification to accept different valuations for producing an identical product, such as copper, silver and zinc and for Yamana the market is grossly overvaluing production from producing these metals in comparison to if they’d been produced by say, Quadra.
Also, the market tends to fail to adjust valuation for reserves based on the quality of the reserves. The low metal values per ton for Yamana suggest that the reserves should be valued at a significant discount when you consider that the mining costs per ton tend to be fairly fixed costs. When grades are $50/ton, $10 processing per ton is 20%. At $25/ton it is 40%.
The gold grades are low and the actual production costs without metals credits are high. When Chapada’s costs are fairly allocated between copper and gold you get 66c/lb production costs for copper and $187/oz for gold.
Yamana is sufficiently overvalued that the “premium” offered to Northern Orionand Meridian is completely fiat.
Do your own due diligence, these are strictly my opinions. For the record, I owned Northern Orion until I realized it could very well be taken over by some bubble-valued gold producer.

Read More......

Commodity Prices - The 50-year low and 20-year average

In 2002 commodity prices were at a 50-year low, and with zinc, for example, the price was about half of the 20-year average price.

That 20-year average price was mostly in a bear cycle. Bear cycles lead to under investment. Existing mining companies are sustain operations without replacement investment. For example, the mines are already built; so only maintenance costs required. They already have drill results telling them where to mine, so exploration budgets can be cut, and that was happening. Individual mines depreciate in value as the minerals are mined and the life of the mine declines, so in real terms, without re-investment the value of mining companies was declining during the bear cycle.

Furthermore, if you look at what happened when prices hit that 50-year low in 2002, well, companies went into bankruptcy. Other companies sold off valuable assets at bargain basement prices. Look at how Roca (ROK-V), Northern Orion (NNO-T) and Eastern Platinum (ELR-T) all got started. The assets they control they got for probably 10c on the dollar.

Another example, Silver Wheaton purchased 37.5% of the Alumbrera mine in 2003 for $270.5 million, which was later acquired by Goldcorp. In 2006 that 37.5% interest accounted for $334 of the $455 million of operation earnings from the 15 mines listed with operations for Goldcorp. Alumbrera is in Argentina, where costs are relatively low and it was sold in a fire sale!

The mining industry in BC, where I live, practically died at those 20-year average prices, even where the mines were already built. And it was happening across Canada. Look at Teck Cominco’s (TCK.A-T) old Pine Point mine, the property now owned by Tamerlane (TAM-V). It was the site of one of Canada’s most profitable mines and it was shut down and practically given away with 70 million tonnes of historical, ie, not NI 43-101 compliant, resources with 1.59% lead and 4.19% zinc in 34 deposits. That is about 2.5 billion pounds of lead and 6.5 billion pounds of zinc.

Competition from countries with cheaper wages and costs played a significant roll in the demise of Canada’s mining industry. With those 20-year average prices gems were treated as pyrite. And that should be a wake up call for just how much relative value you should give to metals in the ground versus a company’s earnings in your own investment portfolio.

It seems to me that using that 20-year average price as a meter stick to come up with long term price projections is not reasonable given that it was a period of cannibalism of assets to maintain operations and I think that is partly why some analysts keep under estimating the strength of future commodity prices.

And, if you take a look around at what is happening in other countries that have developed a strong mining economy, the standard of living is rising, as are their wages. The proliferation of news releases about strikes is enormous, and wages are going up. The wage discrepancy is shrinking and the world is running out of countries where you can build a mine for slave labour wages.

And with increasing standards of living, when workers can actually participate in the economy rather than just exist in the economy, they stimulate the economy in a way that gives the enormous rates of economic growth that we are seeing in developing countries.

Those in the mining industry and those highly bullish on commodities insist that it will take years of new investment to meet current demand and that we are in a super cycle for commodities because of the gross level of under investment and because of the economic growth in developing countries. The bears of the market look at that 50-year low and the 20-year average price and use that as a meter.

There is no question that the high commodity prices we are seeing today are unsustainable in the long term, and the further out the prediction on where prices will be the more likely it will be wrong, but it makes far more sense to me that the next 20-year average price will be significantly higher than the previous 20-year average price.

Read More......

The Leverage of Earnings

"Around 2000 I left my job and cashed out my pension and put it into commodities," was what a colleague was saying. "I had $14,000 and it is now a quarter of a million."

The commodities bull run created an enormous leverage of earnings. Take Northern Orion, a junior start-up company around the beginning of the bull run and now it has $230 million in the bank. The big players have reported billions of dollars of earning.

Eastern Platinum has gone from a junior start-up to a company with a $1.5 billion dollar market cap. Its earnings are a little on the low side for the market right now, but with 700% expansion of mining production over 5 year planned, high grades of platinum resources and demand for platinum as both an industrial metal and a precious metal, they will have good growth in earning..

Roca is a new start-up that if moly prices remain where they are should make in the range of 25-30c/share in either Q3 or Q4 this year.

Blue Note is also building a new mine and should have earnings of 2-4c by Q3 or Q4 this year. Blue Note will perform nicely this year.

Aur Resources has gone from a $2 stock in 2000 to $23 today with 2006 earnings of $3.23 per share, and 60-70% growth in production planned over the next 2 or so years.

To have been there at the beginning of the bull run, at the period when earnings exploded.

There is one stock I've recently looked at that an unfortunate hedge decision reduced its earnings to about 20-25% of what they would have had without the hedge. The company's earnings were 87c/share for 2006, and with only 40 million shares, taking a $144 million dollar loss and still making money is amazing. $144 million is about $3.60/share of cash flow that they didn't have to put to earnings. There is a thing called taxes that they would have to pay on that, so it isn't quite that good, but it is very sweet overall.

The stock is Quadra and this stock is in a position to see a leverage of earnings much like the early bull run days, indeed, 2007 will be Quadra's bull run.

Quadra's hedge which limited them to an average of $1.72/lb of copper for 2006 hit them at both end, earnings and costs. There is a thing called "price participation" where as the price of a commodity increases, smelter companies get a cut of that increasing price. Quadra had hedged at $1.60 and copper went as high as $3.99/lb on the LME. So, not only did Quadra forfeit 60% of the potential income, they had to pay smelter costs as if they were getting $3.99/lb. So Quadra paid the full costs of the bull run, but had none of the benefits. The average LME price for copper for 2006 was $3.05/lb. Quadra didn't get an average of $1.32/lb of "free" money.

Quadra has even more leverage of earning to come. They ran into a few problems with production and produced 117 million pounds of copper. They believe they've worked out those issues, certainly towards the end of Q4 their recovery rates improved considerably, and they've given guidance of $125 million pounds, an small increase of 7%. But, they are in the process of building a second mine which is planned to start producing late 2008 and will add 75 million pounds of production per year, so a two year growth in production rate of 67%. There are a couple downsides, increased debt to pay for building the new mine, but that is highly preferable over dilution that would limit earning potential forever.

2007 is going to be Quadra's year for stellar performance.

QUA Toronto, QADMF.PK in the US.

Read More......

How I Discovered the Gold Bubble

I have been investing in the stock market and one of my investment "finds" started to have a sell-off when I thought it was undervalued. I needed to be sure that I had properly assessed my stock of interest, so I started on a journey of comparing two stocks for market valuation.

The stock that interested me is Northern Orion. The stock that I decided to compare it to was Goldcorp. I chose Goldcorp because Northern Orion owns 1/8th of the Alumbrera mine and Goldcorp owns 3/8th. It seemed that they should have similar valuation based on this one interest.

What I discovered was that Northern Orion was trading for about 10c on the dollar compared to Goldcorp. I still strongly believe that Northern Orion is undervalued, I never expected to find a gold bubble in mature gold stocks, one that in my mind is as serious as the tech bubble.

Read my analysis and decide for yourself. Aside from the copper concern, the majority of these concerns apply to mature gold stocks and will make them under perform beyond anyone's expectations.

The over valuation of Goldcorp

Goldcorp is a company with 702 million shares that took over Glamis in late 2006. Currently a check on any stock website is still not showing the 280 million extra shares from that takeover and is enormously understating market cap. At a share price of about $28.50, Goldcorp has a market Cap of $20 billion.

To understand why Goldcorp is overvalued, these things need to be examined and evaluated:

1. The leverage of earnings of both copper and gold.
2. The price elasticity of gold bullion to gold stocks, ie, market cap.
3. The increasing cost of acquisitions.
4. The roll of the life of a mine - increasing rates of depletion.
5. The roll of lower quality gold properties.
6. The roll of depreciating mines.
7. The level of reserves to market cap.

Major Concern #1 - negative leverage of copper

When I looked at Goldcorp, it was prior to the Glamis merger. At that time I found from reading the financials that in Q2/06 64% of earnings came from one mine for Goldcorp, the Alumbrera mine, and for the first 9 months of 2006 60% of earnings came from Alumbrera. Alumbrera is copper, not gold. I'm not entirely sure for Goldcorp, but for Northern Orion in Q2/06 they got $4.44/lb average. When 60% of earning come from one mine, where the price of the commodity is going down, that is huge in terms of loss of income for the business.

Before the merger, there were 60% of the number of shares that there are now. This means that for the year, it can be expected that about 1/3rd of earnings for the entire company will have come from copper.

If you look at the average price of $1.01 prior to the bull on copper, copper increased to roughly 440% of its previous price. I truly believe this leverage effect of earnings on Goldcorp has been grossly under appreciated in terms of how Goldcorp can never again have the stellar performance of the past.

Alumbrera has a twofold effect on earnings for Goldcorp. First, for 2005, the earnings were not subject to the 20% royalty, so earn estimates for Goldcorp for Alumbrera for 2005 based on those copper prices will be less. The upside is that 2006 only saw gross earnings without that royalty payment for Q1, so 2006 earnings are not completely plumped up by an unrealized 20% decline in copper prices due to the royalty kicking in.

The second effect is that copper prices are going down and copper LME stocks are going up. Traditionally demand for copper is lower this time of year, so even though copper stocks are going up, that may turn around this quarter, but copper stocks are increasing rapidly. The other thing about copper, every producer that can has increased their existing output as best they can. This has in the shorter term increased supply, but in the longer term shortens mine life.

I have not done the required homework, so I really don't know how much of the new production is new mines, and how much is increased output of existing mines. But, my overall sense from my reading is that producers have gone for the fastest path to increasing production, which was to eliminate inefficiencies in current operations, Alumbrera is not exception, production has been increase by 10%.

The other thing that may have happened as well is that mines have not kept up on maintenance the requires reduction in output. As copper prices decline, those scheduled maintenance needs will happen, so in some respects, In the short term there may be an unsustainable increase in production. If I'm wrong, copper prices will decline further this year and will probably settle in the $2.25 range. I do not see copper averaging at $3.40 as predicted in the BMO analyst report, but possibly in the $3 range, but the recent decline in copper price and increases in stock make that an unlikely prospect.

The effect of the decline in copper prices is enormous for Goldcorp, as such a high percentage of its earnings were from copper. With 168 million pounds of copper, every dollar decline in copper requires gold to go up $54 at current production rates just to offset it. So, from the high of $4.44 to today's low of $2.51, based on a production of 2.8 million ounces, gold has to go up $92/oz for Goldcorp's earning to remain constant. I have taken into consideration that 20% royalty in this calculation.

Major, Major, Major Concern #2 - reduced leverage of Gold.

This concern is more a concept than actual numbers, but this concept will play out in earnings. It mathematically has to. I believe that the concept of leverage of earnings is being utterly ignored in analysts and brokers alike, and not recognized in terms of its ability to never again give repeatable results regardless of what the price of gold does now.

The simplest and most dramatic way to demonstrate this concern is to do a mathematical analysis using ratios. I teach ratios to kids in grade 8.

Say you have a producer who when gold was $300/oz managed to make $10/oz profits and the earnings/share worked out to 4%. Say the share costs $1. Now say gold is $600/oz. So now profit is $310 and a simple ratio gives earnings (310/10)x4 = 124%. This kind of leverage of earnings made gold such a stellar performer up to now in the market, but mathematically, it can never be repeated. The leverage ratio here is 31, utterly enormous. Share price would then adjust, go up 31 times, to $31 and the return would again be 4%.

What has happened is share prices have adjusted to market cap and shares have gone way up, so earnings are again 4%. Market cap has also gone up 31 times. If it was 1 billion, now it is 31 billion. Keep everything else constant, costs are still $290 for the sake of this analysis of the reduced effects of leverage.

So, now say gold goes up another $300, to $900. Now profit is $610. The leverage effect is now (610/310)x4 = 7.9%. The leverage effect now is 1.97. The reduced leverage effect of increasing prices is 31/1.97 is 15.8. This is a decimal number. I also teach percents to kids in grade 8. This is a reduction of leverage of 1580%, providing costs remain constant.

Leverage of earnings early in the bull run played a dramatic effect on the increase in earnings on gold shares from increases in gold prices in a way that I believe is *unrecognized and unrepeatable*.

This incredible leverage of earning early in the bull run, in my assessment, is probably responsible for erroneously justifying P/E of 25 to 50 are acceptable for gold stocks because profit grow rapidly with increasing gold prices. The stellar leverage is a one time only deal. It declines further with every dollar increase in the price of gold.

Major Concern - Price Elasticity of Bullion versus Market Cap Concern

This is a simple mathematical analysis that I've talked about with high school students in the classroom in terms of what I see happening with gold stocks in general.

Take gold at say a price of $625/oz. Say you buy an ounce and the gold price goes up to $725, or by $100. Your investment has increased by 16% and you own the gold bullion.

For simplicity, say the market cap of Goldcorp is $20 billion (it was very close to that). Their production forecast is 2.8 million ounces of gold, which at @ a $100 increase in the price of gold would bring in an additional $280 million. So, the absolute value of how much earnings could go up relative to market cap is 280/20000*100% = 1.4%. So, if earnings were 4% they could go up to 5.4% if gold went up $100, but taxes also have to be paid.

The price elasticity of the raw numbers of what you actually have is the bullion is 11 time better to own right now than the gold stock, if you believe that gold is going to go up in value.

What is really remarkable here, is that not only is the level of earnings pathetic with the stock in comparison to bullion, you not longer own the gold, or essentially you have a very negative return. The gold has been sold.

Major concern - Increasing cost of Acquisitions

The cost of replacement properties has increased dramatically. I've pasted a recent report at the end. At the beginning of the bull run reserves cost about $33 oz. The Glamis take-over cost $175/oz. This is around $140/oz increase in acquisition costs.

The exact numbers don't matter, for simplicity, there is about $140/oz increase in gold replacement costs. Previous analysis was just looking at all things constant. All things aren't constant, and in fact work against profitability. Costs are increasing. Gold needs to go up to about $750/oz just to maintain earnings in terms of what those replacement cost are.

For Goldcorp, $140/oz in increased costs translated to 2% less to earnings per share.

Major concern - The life of a mine - increasing rates of depletion

Some of the spins I've read on the life of mine gives that a short mine life is a good thing because mines stop producing and it gives constant demand.

My spin on it is very different.

Red deer, a Goldcorp's second largest contibutor to earnings, has a mine life left of 12 years. Alumbrera has a mine life left of 10 years. Prior to the merger, those two mines were making 80% of Goldcorp's earnings. There are 23 properties listed. It means that one, and sometimes two mines need to be built every year just to keep up, never mind growth. Replacement is enormous...

In the shorter term for Goldcorp you see production going from 2.8 million ounces to 3.5 million ounces. From that point on you see a rapid decline in output due to the end of the life of the mines, with 60% of the 3.5 million ounces in mines that come to the end of their life within 12 years.

The rate of depletion of Goldcorp gold reserves without replacement looks something like this:
2005 - 40.5 million ounces
2006 - 38.5 million ounces, 2 million mined, depletion, 5%
2007 - 35.7 million ounces, 2.8 million mined, depletion, 7.3%
2008 - 32.6 million ounces, 3.1 million mined, depletion 8.6%
2009 - 29.3 million ounces, 3.3 million mined, depletion 10.1%
2010 - 25.9 million ounces, 3.4 million mined, depletion 11.6%
2011 - 22.4 million ounces, 3.5 million mined, depletion 13.5%
2012 - 18.9 million ounces, 3.5 million mined, depletion 15.6%

This means that Goldcorp is in a squeeze position of having to constantly be acquiring new properties to keep this monster machine going. It puts Goldcorp at major risk for increasing costs, and indeed, the costs never stop because of the constant need for recapitalization.

Major concern - depreciating mines

Mines are depreciating assets. The average life of a gold mine is 14 years.

To my way of thinking in terms of valuation, that means that earnings need to be 7% to make up for the average depletion rate plus inflation plus whatever it is you expect for the risk you take. Strictly my opinion here, but without strong other mathematical reasons and evaluation, a P/E of 10 is the minimum as to where you start, and then make adjustments up or down based on the fundamentals of the gold stocks. How much is being added to reserves and how much is being mined. If new reserves are being added at the same rate as the depletion, a P/E of 12-15 may be justified.

Another way of looking at it for Goldcorp based on the 41 million ounces of reserves and 3.5 million ounces of production fore casted in the future, well, that means that in 41/3.5 = 12, so in 12 years all you own is empty holes, with the gold all mined and sold.

12 years of earnings at 3%, if Goldcorp can even manage that, gives earning returned over the life its reserves that is only 36% of market cap. With a P/E of 12 you'd get 100% of market cap returned, with no time cost of the investment. With an estimate of 2006 earnings at $1.03, a P/E of 12 would give a share price of $12.38.

Goldcorp has a higher rate of depletion than average, so imho, even a P/E of 8 for it is generous.

Major concern - Lower quality properties available for replacement.
Again, from the source below, there has been a drastic reduction in property finds with more than 2.5 million ounces. With production rates fore casted to be going up to 3.5 million ounces, there needs to be 1-2 of these properties per year found and purchased just as a replacement activity. The low supply should further increase costs of acquiring these properties.

Lower quality properties generally means higher mining costs.

Major concern - value of reserves to market cap

Goldcorp's web site reports for 2005 the following reserves:

40.5 million oz gold @$425 = $17 billion
687 million oz silver @$10 = $6.9 billion
1.5 billion lb copper @$1.35 = $2 billion
3.7 billion lb lead @$0.50 = $1.9 billion
8 billion lb zinc @$1.25 = $10 billion
Total: $38 billion

It isn't corrected for the 2 million ounces of gold production for 2006, but that can slide...

And there are properties that haven't been properly assessed. There may be 10 million ounces in those properties, or there may be 100 million ounces. The properties have not be assessed.

However, what they can show gives a mere 2.2 times the market cap (using $17 billion market cap).

It seems prudent that market cap to what they can show at bearish prices should be at least 5 times the known reserves. This valuation alone puts Goldcorp's share price at $10.80.

Summary of concerns about Goldcorp

• Negative leverage of copper - gold must go up $90 to cover.
• Declining leverage of gold - leveraged increases in earning can never match early performance -- it is mathematically impossible.
• Price elasticity of the bullion is 11x that of the stock.
• Increasing cost of acquisitions means that gold must go up $140 just to cover.
• Depreciation of mines is higher in the gold industry than any other mining industry.
• Quality of replacement properties is declining, meaning costs will increase.
• Availability of replacement properties is declining meaning acquisition costs can further be expected to increase.
• The ratio of reserves to market cap for Goldcorp is disgraceful.

At the end of my analysis of Goldcorp I was truly horrified that anyone would be recommending this stock. Certainly if any of my analysis has merit, many reputations will be seriously hurt. But personally, I wouldn't buy Goldcorp at $10. I simply don't see growth potential at that price.

My Conclusions:

• Gold prices must increase $230/oz to maintain earnings for Goldcorp.
• Assets are depleting at a much higher rate than earnings.
• Goldcorp is trading at about 3 times its value.
• All Gold companies are facing increasing costs, reduced leverage, and greater difficulty for finding replacement properties.

(stocks with higher costs to at the start of the bull run have not increased to the degree that low cost producers increased, they simply never had the same leverage of earning to pump up their stock prices.)

The Under Valuation of Northern Orion

I stated that I saw Northern Orion has being grossly undervalue. All of its earning come from copper, so it too should expect much lower earning from its existing operations. My interest in Northern Orion came not from it current earnings, but it massive reserves and massive growth prospects, comparable to the potential of Goldcorp 6-7 years ago. Northern Orion has massive increase in earning opportunity even in a declining-copper price market.

Points that favor Northern Orion

1. Market cap to reserves is enormous.
2. Strong cash position.
3. Expected cash from warrants can provide some capital costs.
4. Good cash flow from Alumbrera.
5. Aqua Rica property is well studied and Northern Orion has applied for building permits.
6. Production increase is forecast to increase by 660% when the new mine starts.
7. Low cost producer because of net credits of gold and molybdenum.
8. Lower depletion rates.

Reserves to Market Cap for Northern Orion

Northern Orion has two properties, its 1/8th interest in the Alumbrera mine and Agua Rica.

The Alumbrera mine has 10 years of life left, Northern Orion's share is 50 million pounds per year of copper and 75,000 ounces of gold, exactly 1/3 of what Goldcorp gets from this mine.

Simple extrapolation, total reserve of this property is 1/2 billion pounds of copper and 750,000 ounces of gold, which at $1.35 for copper and $400 for gold is $0.675 billion for copper and $0.300 billion for gold, or about $1 billion.

The Agua Rica property is Northern Orion's hidden gem.

The feasibility study gives this total as to what can be mined over a 23 year period. This is more conservative than just looking at the reserve because recovery rates are taken into account. There are 6 million ounces of gold in the reserve, but only 3 million ounces are considered recoverable as about 50% of the reserve is not recoverable in the mining process. There are 13 million ounces in the resource. There are 21.4 billion pounds in the resource for copper and 1.7 billion pounds for molybdenum.

The recoverable metal estimates for Agua are
7.6 billion pounds of copper @1.35 = $10.3 billion
3 million ounces of gold @400 = $1.2 billion
360 million pounds of molybdenum. @12 = $4.3 billion

The two properties combine give $17 billion at $1.35 for copper, $12 for molybdenum and $400 for gold.

Diluted, Northern Orion has 221.5 million shares. At $3.70/share that gives a diluted market cap of $820 million ($560 million undiluted).

So, at bearish prices reserves to market is 21 times. A valuation of 1/10th production forecasts at bearish prices gives a valuation of $7.40.

Strong Cash Position and Warrants

Northern Orion has $180 million in cash in the bank. Should the fully diluted market cap be realized, it will have an extra $160 million from warrants. That's $340 million dollars, leaving only $400 million of market cap for valuation of the rest of the assets.

If you take the bearish value of what's in the ground, $17 billion and compare it to the rest of the market cap, well, that's 42 times the market cap less cash position.

Strong cash flow from Alumbrera

For 2005, with average copper prices at $2.37 equity earning were $46,755,000, and cash flow was $75,500,000. Earning per share at this price was $0.31. This is in the "ball park" of where copper prices can be expected and cash flow for the size of the company is strong.

Over the three years to bring the new mine to production, it is reasonable to expect another $150 million to retained earnings which can be used towards the construction costs of the new mine. Quarter 2/06 had cash flow of around $56 million alone. This drastically reduced estimate takes into account strong declines in copper prices, but is still strong cash flow.

Aqua Rica is ready for building.

The Aqua Rica property has an strong investment in drilling and feasibility studies and is at the point that permits have been applied for to build the new mine. The down side is that it is expected to take 8-10 months to get the permits approved.

Production growth is enormous compared to current operations.

The new production is expected to be:

• 368 million pounds of copper
• 120,000 oz gold
• 15.4 million pounds of molybdenum.

The increase of cash flow at prices of $2 for copper, $425 for gold and $12 for molybdenum is $736 million for copper, $51 million for gold, and $185 million for molybdenum, for a total of $970 million dollars.

At a price of $2.37 for copper Alumbrera earned $0.31/share. A simple ratio extrapolation for a $2 price with a 660% increase in production gives (2/2.37) x (7.70) x 0.31 = 6.5 x 0.31 = $2/share earnings. This doesn't take into account there would also be molybdenum, which is like a bonus production. 185/221.5 = $0.84, so earnings should go to somewhere between $2-3/share.

The cash flow situation is that Northern Orion will have in the range of a half billion to pay for the new mine and will need to finance $1.5 billion. Their assets and cash flow are strong enough to do this without further dilution.

The new mine production is going to generate a cash flow in the range of what Alumbrera generates, only this will be 100% Northern Orion owned. To put this into perspective, Northern Orion's cash flow can be expected to be in the range of 40-50% of Goldcorp's 2007 cash flow, yet it has a market valuation 1/20th of that of Goldcorp. ($820m vs $17 billion) Further, the difference in the mine life (23 years) and availability of replacement reserves means that Northern Orion would not be subjected to they same types of increasing costs.

Low cost producer due to gold and molybdenum cash credits, lower depletion rates

Aqua Rica's cash costs for production would make it one of the lowest cost producers. This is the type of circumstance that led to the stellar growth and returns for Goldcorp, with a difference, depletion rates are lower. After the new mine is built, the shorter term, depletion rates are very high and cash flow is higher. Total production for 2012-2016 for copper would be 418 million pounds. It declines to 368 million pounds in 2017 when Alumbrera has come to the end of its life, and in 2022 the highest streams of copper are expected to be mined and production further declines to 300 million pounds for another 13 years.

The rate of depletion of Northern Orion's copper reserves looks something like this:
2006 - 8.1 billion pounds
2007 - 8.05 billion pounds, 50 million mined, depletion, 0.6%
2008 - 8 billion pounds, 50 million mined, depletion 0.6%
2009 - 7.95 billion pounds, 50 million mined, depletion 0.6%
2010 - 7.7 billion pounds, 250 million mined, depletion 3.1%
2011 - 7.28 billion pounds, 420 million mined, depletion 5.5%
2012 - 6.86 billion pounds, 420 million mined, depletion 5.8%

The cash flow is such that capital cost can be paid back while there is the higher production from the new mine as well as the continued cash flow from Alumbrera.

With longer mine life, Northern Orion is never in the type of squeeze position that mature gold stocks are in. Over the long term, they are not subjected to the same squeeze to keep production going to ensure maintenance of earnings, never mind to increase them.

Summary of under valuation of Northern Orion

• The value of what's expected to be sold at half of today's market prices is $17 billion, 22 times the diluted market cap, and using a value of market cap being 10 times bearish price estimates give a today value for Northern Orion of $7.40.
• Earnings per share can be expected to increase to about $2/share even if copper is $2/lb. With a target P/E of 10, once production is in full swing, target price can be $20/share. With a target P/E of 8, target price can be $16.00.
• Northern Orion has a strong cash position, 35% of it undiluted market cap in cash, and 46% of its diluted market cap taking into account the cash from warrants.

My Conclusion: Northern Orion is grossly undervalued. It is a strong buy to $7 based of property holdings alone.

Everywhere I look, I think I've been conservative towards Northern Orion, and actually generous towards Goldcorp. For example, I've stated 10 times bearish prices for Northern Orion, using bearish prices, whereas for for Goldcorp I've suggested it should have 5 times the reserves at bearish prices relative to market cap. The estimate for Northern Orion puts copper at $1.35, highly, highly bearish. The estimate for Goldcorp uses reserve, for Northern Orion the estimate is corrected for the non-recoverable percentage in the mining process.

Copper prices have declined faster than expected, but there is a new mine entry barrier price. Northern Orion's entry price is much lower than average due to low production costs, and the enormous reserve was acquired at very low costs.

The recent Phelps Dodge merger puts an in the ground valuation for copper at $0.70. Their average production costs are $0.50/pound. With Northern's Orion's net of metal credits production costs at -$0.02, it is simply far more competitive. Another tiny cap stock, Equinox, shows production costs of $0.70/lb.

Starting at a copper price of about $2.25 high cost producers start to have problems raising capital costs, and it increase from there. The sell off of Northern Orion indicates how true that is in terms of being able to attract capital for investment as copper prices decline. Copper was able to stay at around $1/lb for so long because land and capital costs had long been paid for, and the long life of mines enabled them to simply continue as ongoing concerns, without capital for replacement or new investment. And, at those prices, mines were going bankrupt.

Gold Takeovers Reach Record on Lack of New Supplies

By Choy Leng Yeong

Dec. 27 (Bloomberg) -- Gold-company acquisitions this year surged to the highest level in at least a decade, and the industry may continue its buying spree in 2007 as producers struggle to find new deposits.

Goldcorp Inc.'s $8.5 billion acquisition of Glamis Gold Ltd. was the biggest of 357 deals valued at a total of $24.3 billion this year, data compiled by Bloomberg shows. That eclipsed the $16.2 billion spent last year on 341 transactions, including Barrick Gold Corp.'s $10 billion purchase of Placer Dome Inc.

Producers are rushing to boost supply because mines are being depleted faster than new reserves are being found, and a six-year rally in gold prices is providing cash to buy assets. The number of discoveries of at least 2.5 million ounces has declined for eight straight years, according to Metals Economics Group in Halifax, Nova Scotia.

``The driving force behind the M&A is that you have difficulty finding new gold mines,'' said Graham Birch, who helps manage $27 billion at BlackRock Investment Management in London. ``It's all about trying to get access to reserves.''

From 1992 to 2005, the world produced 1.1 billion ounces of gold, or 1.8 times more than the new resources discovered among deposits of at least 2.5 million ounces, Metals Economics Group said.

The drop in new reserves followed years of reduced spending on exploration as gold fell to a 20-year low of $253.20 an ounce in 1999. Worldwide exploration budgets fell to a 12-year low of about $780 million in 2002, said Jason Goulden, director of corporate exploration strategy at Metals Economics.

`Scramble for Land'

``There is a scramble for land,'' said Ian Cockerill, chief executive officer of Johannesburg-based Gold Fields Ltd. ``From about 1996 until about a couple of years ago, there was a marked decline in the amount of exploration dollars. The industry is staring down the barrel of the gun that says, `Where are the replacement ounces coming from?'''

Gold Fields, the fourth-largest producer, earlier this month completed a $1.53 billion purchase from Barrick of half of the world's biggest deposit, the South Deep mine in South Africa. Gold Fields is buying shares in Western Areas Ltd., which owns the rest of South Deep. The deal will increase the company's reserves by about half.

The price of gold has more than doubled to $630.30 an ounce today from a 20-year low in 1999. The precious metal reached a 26- year high of $732 on May 12. The rally, fueled by investors seeking a hedge against inflation or an alternative to the dollar as it fell against the euro, has spurred demand for new reserves.

Cost of Reserves

The cost of reserves rose to a record $120 an ounce in 2005, compared with a low of $33 in 2000, said James Lowrey, a senior analyst at Metals Economics, which tracks more than 1,450 companies and deals of at least $50 million since 1995.

Gold Fields CEO Cockerill admits he paid top dollar for the South Deep mine at $104 an ounce. ``It is certainly one of the more expensive acquisitions that we have made'' compared with the company's historical average of $60, he said. ``But then again, it's a very special ore body.''

The mine, west of Johannesburg, contains as much as 29.3 million ounces, equal to about a third of the world's annual gold production. Gold Fields plans to study the viability of expanding annual production to 1 million ounces, from the 800,000 ounces expected yearly by 2011.

Vancouver-based Goldcorp spent about $175 for each ounce of reserves it acquired in the Glamis deal last month, and Toronto- based Iamgold Corp.'s $1.1 billion stock acquisition of Cambior Inc. valued each ounce at about $117, Lowrey of Metals Economics estimated.

Doing Deals

Doubling resources is a ``big rationale for doing this deal,'' said Goldcorp Chairman Ian Telfer, who has made more than eight acquisitions in the past four years. The purchase of Glamis helped Goldcorp overtake Johannesburg-based AngloGold Ashanti Ltd. as the world's third-largest gold producer by market value.

Citigroup Inc. was the top investment bank with five deals worth $11.6 billion, accounting for 48 percent of the market share. It advised Glamis on its takeover by Goldcorp. JP Morgan ranked second with $11.4 billion and seven deals, including Glamis.

Global gold production in the nine months ended September fell 2.2 percent to 1,804 metric tons from a year earlier, London- based researcher GFMS Ltd. estimated. The lack of new supply will help boost gold prices by $200 over the next two years, topping $800 an ounce, Telfer said.

``There is definitely a sense that the industry -- which is really good for gold -- is kind of flat to shrinking,'' said Barrick Chief Executive Officer Gregory Wilkins. ``Placer was important for positioning the company for dealing with the industry challenges.''

Gold-Company Shares

Shares of Toronto-based Barrick, which completed its acquisition of Placer Dome in March, rose 6 percent this year. Denver-based Newmont Mining Corp., whose bullion sales may plunge 14 percent this year, has fallen 15 percent, the biggest drop among the 16 companies in the Philadelphia Stock Exchange Gold and Silver Index.

Newmont, which spent $225 million to boost its stake in a mining project in western Australia this year, cut its 2006 sales forecast three times, most recently in September, because of lower output in Ghana and Uzbekistan. The company said Sept. 27 that its gold sales may fall 14 percent this year to 5.6 million ounces from 6.5 million in 2005.

Freeport-McMoRan Copper & Gold Inc., owner of the world's biggest gold mine, last month agreed to buy copper producer Phelps Dodge Corp. for $25.4 billion. Kinross Gold Corp., Canada's third- biggest gold producer, agreed to purchase rival Bema Gold Corp. for $2.84 billion in stock to expand in Russia.

Barrick's Wilkins said his acquisition strategy won't be affected by short-term changes in prices, which have fallen 14 percent from the 26-year high reached in May.

More Bids

Barrick may make a bid for New Orleans-based Freeport to boost reserves and lower operating costs, CIBC World Markets Inc. said in a research note on Dec. 15. Both companies have declined to comment. Barrick on Dec. 7 failed in its $1.71 billion hostile bid for Vancouver-based NovaGold Resources Inc.

Kinross Chief Executive Officer Tye Burt said takeovers may get a boost from the recent slump in prices.

The decline may bring ``more targets into a price zone'' to encourage acquirers, Burt said. ``In a strong commodity price environment, it's always tough to reach price agreements. Everyone's trying to protect their production profiles.''

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