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Gold miners tarnished by tumbling reserves

For the world's major gold mining companies, bullion's sharp price decline has put them in an unfamiliar and not altogether comfortable condition: They're shrinking. The question now is whether the downsizing is destined to continue – or if a bit of price stability will lure them back into their comfort zone of rebuilding reserves through acquisition.

A new report from independent research firm SNL Financial notes that the combined gold reserves of the five biggest global gold producers (Barrick Gold Corp., Newmont Mining Corp., Goldcorp Inc., AngloGold Ashanti Ltd. and Kinross Gold Corp.) fell by 11 per cent in 2013. Their reserve total has retreated to 2006 levels, wiping out six years' worth of growth.

The culprit was the gold price. As it tumbled from $1,800 (U.S.) an ounce in late 2012 to $1,200 in late 2013, the miners were forced to slash the price assumptions they used in their reserve calculations – and remove higher-cost ore from reserve estimates as producing it was no longer economic.

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The result has not only been substantial and costly writedowns to reserves, but also a shrinking reserve base that is far from business as usual at the big miners. In a business where reserves are traditionally considered the key to sustaining future production and assuring growth, companies have instead been forced to focus on reducing costs and narrowing their scope. Big companies have been looking more to sell off assets than buy new ones.

At the same time, though, gold mining reserves have become decidedly cheap. In terms of market capitalization for those five gold majors, the market is now paying about $180 an ounce of reserves – only a little more than half what it was paying in 2011, and 25 per cent less than it was paying for similar reserve levels in 2006.

This may present tempting buying conditions for the big producers as their balance sheets become healthier and the gold price appears to stabilize (it has been holding steady near $1,300 for most of the past two months). Indeed, just last month Barrick came close to a deal to acquire Newmont – perhaps evidence that the big producers, despite their continuing talk about reducing costs and right-sizing their portfolios, may be warming to more attractive M&A conditions.

But perhaps the cheap valuations on reserves are more of a warning from the market than an invitation. Maybe investors aren't all that confident that the reserve writedowns aren't over.

Indeed, the SNL report noted that the gap between the market price for gold and the price assumption built into reserve estimates has narrowed – and for some of the big producers, dangerously so. Newmont and Goldcorp are using $1,300 an ounce in their reserve calculations; that's slightly above the average price so far this year. If gold were to turn downward again and settle at even moderately lower levels, this could mean more reserve writedowns for companies that have gambled on these more aggressive reserve price assumptions. And even the more conservative miners, such as Barrick and AngloGold, have only gone as low as $1,100 an ounce, leaving their reserves also susceptible if gold is still in the midst of a longer-term downward cycle.

It certainly looks as though further downside risk is built into the market pricing. Still, an opportunistic gold major may be able to grab some relatively low-cost reserves at what amount to bargain prices. Certainly, though, a healthy dose of caution is warranted, even if the price looks right.

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