Update: Three Phases of the Secular Bull Market in Gold – By Gary Rosenthal

In our first installment of the ‘Three Phases’ manifesto I wrote:

Phase II:

During phase II the rising pattern of gold will begin to accelerate .  However, the gold mining stocks will experience rising relative strength verses the metal as explosive quarterly earnings reports bring attention to the sector. Takeovers will begin to populate the landscape at substantial market premiums as the larger companies bid for the successful exploration companies that have toiled quietly for more than a decade. Sometime before the end of this phase the major Wall Street brokerage firms will scramble to rebuild a research presence and recommendation lists in an area they have long proselytized against. All of a sudden the smaller companies will successfully be able to come to market and new funds will flood into the exploration area. Very quickly a drilling equipment shortage will emerge and all participants in the industry will experience labor shortages.

The Dec. 13 post concluded with our opinion that phase II had commenced. On Feb. 3rd, less than two months later, the following high profile acquisition occurred offering conclusive evidence that our Dec. 13 proclamation seems wholly accurate:

Fronteer Gold to be acquired by Newmont by way of a Plan of Arrangement. Under the Plan of Arrangement, shareholders of Fronteer Gold will receive Cdn$14.00 in cash and one common share in a new company (”Pilot Gold”), which will own certain exploration assets of Fronteer Gold, for each common share of Fronteer Gold.  The cash consideration represents a premium of approximately 37% to the closing price of the common shares of Fronteer Gold on the TSX as of February 2, 2011 and equates to a value of approximately Cdn$2.3 billion for Fronteer Gold (excluding Pilot Gold).

Fronteer Gold owns a 100% interest in the development-stage Long Canyon project, which is located approximately one hundred miles from Newmont’s existing infrastructure in Nevada.  The proximity of Long Canyon to Newmont’s Nevada operations provides the potential for significant development and operating synergies.  Fronteer Gold also owns a 100% interest in the Northumberland project and a joint venture interest with Newmont in the Sandman project in Nevada, among other assets.  Fronteer Gold has total attributable Measured and Indicated gold resources of 4.2 million ounces and Inferred resources of 1.7 million ounces.

Thoughts on the ramifications of this deal:

NEM is paying $2.3 billion for total attributable Measured and Indicated gold resources of 4.2 million ounces and Inferred resources of 1.7 million ounces and a great deal of attractive long term developmental potential.

The lion’s share of the purchase price is for future potential because FRG has no proven/probable reserves which is what the industry usually pays for.

NEM is very knowledgeable of the area and willing to pay a handsome price for potential located adjacent to its Nevada mining operations.

Analysts are going to have a difficult time using the terms of this deal as a yardstick to measure the takeover value of other junior exploration companies because FRG is such a special situation for NEM.

Nevertheless, I am certain it won’t take long before some enterprising young analyst points out that the total market value of one of our positions in both Fortune’s Favor I(FFI) and Fortune’s Favor Precious Metals(FFPM) (with inferred gold resources of  3.5 million ounces in Nevada) is “only” $28 million. That’s about as far as the comparison goes but the shares could easily multiply several times due to speculative “gold fever” and still not equal 3.5% of what NEM paid for FRG.

A more meaningful comparison would be with another favorite position of the Fortune’s Favor Family of Funds. This Company has proven/probable gold reserves of 14 million oz with more than $500 million cash and cash equivalents on the balance sheet. Said company is still relatively early in the exploration of the ______ Lake region with the potential of proving up more than 20 million oz of gold. If NEM was willing to pay $2.3 billion for FRG with no proven/probable what is the upside potential for this company with proven/probable gold reserves of 14 million oz , $500 million cash on the balance sheet and a current market value of only $2.5 billion?

I expect this type of “yardstick” analysis to rapidly emerge throughout Wall Street over the next few months. Furthermore, we look for more evidence of phase II in Feb/March as we expect signs of equipment strain(sharply rising rig utilization and daily rate increases) and explosive earnings guidance from the drilling companies. As the price of gold/silver march higher we expect additional deals to be announced and a gold/silver “recommendation frenzy” to engulf Wall Street.