Ocampo acquisition and what it says about the sector

Hi Bill!
After the close yesterday AuRico Gold announced it had agreed to vend its Ocampo Mine in Mexico to Minera Frisco, a large Mexican mining operation that is majority owned by Carlos Slim, one of the richest men in the world. The purchase price was $750 million all in cash, and included a 50% stake in an exploration asset. There are many intriguing aspects to this deal.

For starters, the decision to buy a mine in the current market environment suggests to me that the buyer believes higher gold and silver prices are ahead. Even though the asset valuations across the mining sector right now are trending in bargain territory, it only makes sense to do this deal if you are a bull in the metals going forward. Carlos Slim was mentioned on the Cafe about 2 years ago when it was rumored he had forward sold a huge chunk of silver - in the range of tens of millions of ounces - at around the $30 level, as I recall. Even though the metal subsequently traded higher to the $50 range, it did indeed trend back to the price range was hedging. So I think the guy is pretty shrewd in terms of pulling the trigger on a significant transaction, and if he is putting a big chunk of cash on the table now on a bullish bet, investors should be paying attention.

This property acquisition is right in the midst of some of the more dangerous real estate in the ongoing drug war. I have been to this area several times, and in fact drove through the town of Ocampo close enough to throw a rock into one of the open pits that are mined at the project. It is rugged, remote, and well off the reservation. It is also one of the most prospective areas in Mexico for mineral exploration, partly as a result of the previously mentioned considerations. Again, if one is willing to make a mega investment into this part of the world, it does suggest to me that Slim is confident the drug war is not going to spill over into the mining sector, a concept that I am in agreement with.

The value of the deal itself is also important to consider. Ocampo currently has a published resource of 2,228,000 equivalent ounces of gold in all categories. If we ignore the implied value of the exploration asset included in this deal, and just look at the price per ounce for the producing mine asset, it amounts to a cost of about $300 per ounce of gold in the ground. True, there is a strong potential discovery upside baked into this price, and the existing infrastructure is well developed and surely contributed to a higher takeover premium, but I think this deal demonstrates that the entire mining sector is priced in the bargain bin right now. Gold is trading around $1800 per ounce and yet a relatively modern mine, generating a decent operating profit, with a long life mineral inventory, can be picked up for $300 an ounce? There were deals done when gold was trading at only $1000 an ounce that paid a much higher premium on a per-ounce basis.

I am strongly of the opinion we are going to see much higher gold values in the years ahead, but I am even more bullish on the mining sector as a whole. If high quality assets are trading at a huge discount today, later on when this market gets off its ass I think we are going to see high quality mine assets trending to a significant premium to gold and silver. So suffice to say there is a hell of a lot of catching up to do, and when we launch on the next sustained uptrend phase for the miners, it will knock the socks off what even the permabulls think is coming.

About ten years ago I did not even dare to dream that gold would be above $2000 an ounce in this long term bull market. I now think it is going to be a multiple of that before its over. And yet the unbelievable aspect to all of this is that we still have not had a real mania in the PM Sector. There have been a few bullish phases, but no real mania has developed. Yet.

After a brutal 18 months of heart-breaking action, we are long overdue for the next uptrend to kick off. I think one of the early signals that is coming soon is the commencement of major acquisitions of mining assets. There have been a few deals announced so far, but there are a lot of very good projects on the block, and plenty of companies that can afford to do a big deal. More importantly, it is a matter of long term survival that some of the senior miners get very active very fast to start replacing ounces in inventory as depletion of currently operating mines is outpacing the ability of the majors to bring new projects on line. We are going to start seeing more big deals very shortly, and perhaps a bidding war or two along the way. This more than any other factor could start getting more speculative action into the mining sector.

I bought a small trading position in AuRico that I sold earlier today, so I do not have a dog in this fight. But I own a piece of just about every other junior miner in Mexico and have my portfolio loaded to the teeth with superb companies that are vastly undervalued. This market will be one for the ages when it finally gets some traction, and meanwhile investors can buy all they want today on the cheap.
Cheers!
MexicoMike