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Analysis: For the next round of gold deals, small is beautiful

24 karat gold bars are seen at the United States West Point Mint facility in West Point, New York in this June 5, 2013 file photo. REUTERS/S
24 karat gold bars are seen at the United States West Point Mint facility in West Point, New York in this June 5, 2013 file photo. REUTERS/S

By Allison Martell

DENVER (Reuters) - Gold miners may be tempted back into the takeover game by lower prices and the need to replace reserves, but they are likely to shy away from flashy mega-projects that require big capital expenditures.

Mining deals have slowed to a crawl, thanks to a volatile market and pressure from investors still angry about the steep premiums paid during boom times. The pause can't last forever, but the excesses of the last cycle will cast a long shadow.

"Everyone is really gun-shy of the high capex projects," said Randy Smallwood, chief executive of Silver Wheaton Corp , which provides miners with cash to finance mine construction in exchange for the right to buy future silver production at a set price.

Smallwood said projects that use relatively low-cost heap leaching could be more attractive than those with mills. In a heap leach, ore is crushed, stacked and irrigated with chemicals that separate out the valuable metals.

Across the industry, executives have vowed to chase profits rather than production, which often means focusing on higher-grade ore. But projects that require significant capital spending may take years to break even, a risky proposition when commodity prices or tax regimes are volatile.

Jason Neal, co-head of BMO Capital Markets' global metals and mining group, said market volatility has cut down buyers' tolerance for risk.

"They are willing to stress their balance sheet less than they would have in a more robust environment," said Neal, who advises BMO clients on takeovers and other deals.

SAFE NEW WORLD

The first half of 2011 was one of the busiest periods of mergers and acquisitions in the mining industry, according to data from PwC, as miners scrambled to boost production after more than a decade of gold price increases.

But investors have punished companies that bought pricey assets and then struggled with spiraling costs and falling commodity prices, and shares and dealmaking have slumped. There were 649 mining deals in the first half of 2013, down from 1,371 in the same period of 2011, according to PwC.

Gold prices have fallen some 20 percent so far this year, weighing on miners' cash flow. Spot gold traded at about $1339 an ounce on Friday.

Insiders say the weak market is now a buying opportunity.

Centerra Gold Inc Chief Executive Ian Atkinson said the mid-tier producer may be looking for acquisitions next year, once it finalizes a key mining agreement in Kyrgyzstan. Centerra did not buy during the last cycle, in part because prices looked too high, but that has changed.

"We've seen serious adjustments in the market value of a number of these other opportunities," said Atkinson. "Some of these things are not only fairly valued, they may be somewhat undervalued."

Centerra is not looking to take on a huge, complex project. Atkinson said it would look for something to produce upwards of 100,000 ounces, perhaps 150,000 ounces a year, and at that scale, big capital requirements would be unusual.

Not everyone is as cautious as Centerra. China Gold International Resources Corp Ltd , the overseas listing vehicle of state-owned China National Gold, can finance substantial capital costs and is looking for acquisition targets, according to Executive Vice President Jerry Xie.

But he stressed that the price has to be right and the company won't buy something it may have to write down later.

"We know the drill," Xie said. "We know what the true value is. We know exactly what's going on."

DON'T BET THE COMPANY

One thing that sets miners apart from much of the economy is that they oversee wasting assets. While a retailer can build a loyal customer base that will return year after year, every ounce of gold removed from a mine makes that mine less valuable.

That is why miners talk about the need to "replace ounces" by exploring for minerals or buying smaller companies.

Targeting less capital-intensive mines means missing out on some projects with big earnings potential. Take Pascua-Lama, Barrick Gold Corp's massive project on the border of Chile and Argentina.

The capital bill will be steep - up to $8.5 billion, according to the last estimate from Barrick, the world's biggest gold producer - and the project has been delayed by permitting issues.

But when and if the mine opens, Pascua-Lama is expected to have exceptionally low operating expenses, producing some 800,000 to 850,000 ounces of gold a year at all-in sustaining costs of only $50 to $200 per ounce in its first five years.

Barrick has said that given the tough market, it has no other plans to build new mines.

Going forward, it may take cooperation from several companies to keep developing top-tier projects.

"It's not unusual with big projects in other industries to look at consortiums," said Gary Goldberg, the chief executive of top U.S. gold miner Newmont Mining Corp .

Spreading risk around can make it possible to develop these projects, "without betting the company, so to speak," he said.

(Additional reporting by Nicole Mordant and Julie Gordon; Editing by Janet Guttsman and Jim Marshall)

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