Risky business

Chinese gold miners may regret foreign acquisitions

Risky business


Roughly 1,500 African villagers raided a mine in Tanzania in May 2011 in an attempt to steal gold ore. Acting through its London-listed subsidiary African Barrick Gold, the owner, Canada-based Barrick Gold, built a 14-kilometer wall around the North Mara mine to protect it from further raids. A year later, however, it can’t protect the mine against its falling stock price.

Barrick said in August it was in talks to sell its controlling stake in African Barrick, owner of four Tanzanian mines, to state-owned China National Gold. The sale is an effort to shore up its stock price, which had fallen roughly 27% in the year leading up to that announcement. The sale of African Barrick would allow the parent company to focus on less cost-intensive mines elsewhere, part of its strategy to boost shareholder value.

The deal, still in its initial stages at press time, would be China’s latest in a string of gold mine acquisitions. Zijin Mining acquired majority stakes in Australia’s Norton Gold Fields in August and Kazakh miner Altynken last year. Shandong Gold Mining launched a bid for Brazil’s Jaguar Mining last year in a deal that is still pending.

Chinese miners seem likely to push ahead with other foreign acquisitions in the apparent belief that gold prices will remain stable or continue to rise. But perhaps they shouldn’t be so certain. While China’s growing demand and government purchases of the metal could support prices going forward, a weakening economy both in China and abroad may also interrupt the sharp rise in gold prices of the last few years.

Gold on hold

The precipitous rise in the global price of gold began in the early 2000s. The metal’s spot price more than quadrupled from 2005 to hit a peak of nearly US$1,900 per ounce in September last year, as investors flocked to the metal as a hedge against economic uncertainty.

China played a large role in driving prices, making up roughly 20.1% of gold demand by tonnage as of the second quarter, according to the World Gold Council. WGC expects China to surpass India as the top gold consumer this year.

But gold’s consistent climb paused this year, with prices bouncing between US$1,531 and US$1,781 an ounce, WGC figures show. Chinese demand for gold jewelry and gold use in technology both flagged as the economy slowed. In turn, volatile prices caused demand for gold among investors to fall 4%.

Given these uncertain price trends, Chinese investments in gold production are risky. One of African Barrick’s mines produces gold at roughly US$840 per ounce, taking roughly the difference between this price and the spot price as profit, said Dmitry Kalachev, a metals analyst at Canadian investment bank Canaccord Genuity (who himself is bullish on gold). As the spot price of gold sinks, so will the company’s profit margin.

However, gold bulls appear to have the Chinese government on their side. Central banks often buy gold as a way to diversify their foreign exchange reserves away from currencies. The wave of deals may indicate that Chinese miners know something retail investors don’t: A major increase in China’s gold reserves could be imminent.

The People’s Bank of China could be poised to buy gold given global uncertainty and China’s roughly three-year lapse in gold reserve purchases. Gold represents a measly 1.7% of China’s foreign exchange reserve, compared to 77% of reserves in the US, Kalachev said in emailed remarks. Other central banks have been acquiring gold reserves as well, with worldwide governmental demand for gold doubling year-on-year in the second quarter.

“We are likely to see more acquisitions by Chinese gold producers,” Kalachev wrote. “The only way to get more gold in the near term, without significantly affecting the market price (gold market is relatively small), is to continue buying gold producing companies.”

Investors who do expect gold prices to rise can make a variety of China-related plays. Gold bulls could buy physical gold or buy into an increasing number of gold exchange-traded funds (ETFs), including a yuan-denominated Hang Seng RMB Gold ETF launched in Hong Kong in February.

Investors could also buy shares of Chinese gold miners. While China’s largest miner, China National Gold, is not publicly listed, Zijin Mining and Zhaojin Mining are. As of press time, their Hong-Kong-listed shares were down year-to-date, and HSBC had rated both Zijin Mining and Zhaojin Mining a buy. 

But while sell-side analysts seem confident gold will rise, there are risks even in a growing gold market like China. The World Gold Council predicted that monetary easing would lead to an uptick in Chinese gold jewelry demand in the third quarter. But that looks increasingly doubtful as economists extend their predictions on when the economy will bottom out to fourth quarter or beyond. Unless a clear trend in gold prices emerges, many private Chinese investors may stay on the sidelines.