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Route One to Gold Mining Profits

"... Higher-risk doesn't always mean lower cost for gold mining companies. And exploration budgets are likely to shrink as M&A continues to drive share prices..."

AS SPOT GOLD PRICES continue to trend higher, the race is on amongst the biggest gold-mining firms to re-stock their depleted reserves.

Three of the larger gold mining companies have just said they're going to spend record sums trying to find new gold-in-the-ground. Picking the winning stocks - and selecting the junior miners about to receive fresh takeover bids - could pay handsomely.

But don't forget the bigger picture as you chase short-term M&A profits. Because "Route One" to growing proven and probable reserves is most likely to deplete total exploration budgets in 2008 and beyond.

That's only going to support the price of physical gold itself.

This week, AngloGold Ashanti (AU) - the world's third-largest gold producer - said it plans to hike exploration spending by 60% in 2007. The South African miner wants to diversify away from its home base, where total gold output has now sunk by one-half inside 10 years.

Randgold Resources (GOLD), another South African miner, says it's put a team together to scour the central continent for new reserves. It added one million ounces in 2006. Now the CEO, Mark Bristow, has appointed Rod Quick - who recently led the discovery of 200,000 ounces at the Tongon project in Ivory Coast - to lead his 'African Hunting Team'.

Over the next six months, the team will visit at least eight countries including Sierra Leone, Liberia, and the Democratic Republic of Congo - three countries just emerging from bloody civil conflicts.

"Some of these countries are showing potential to change," Bristow told MiningMX.com - and the return of fair government alongside law and order should help make gold mining feasible once again.

But higher-risk doesn't necessarily mean lower cost for gold mining companies. Following a $10 million feasibility study, Randgold's Tongon project in Ivory Coast - where the rebel leader, Guillaume Soro, has just been named as prime minister - is due a final "go ahead" decision at the end of next year. The capital cost of developing the mine, according to figures published by MiningMX, would then work out at around $625 per ounce.

"The pioneer junior companies are already in these countries," says Bristow. "We are talking to them and meeting the governments and filling in our geological information box.

"We would like to believe there's merit in us motivating to be the partner of choice because if [the juniors already there] do a business combination with us, their shareholders will get a better exposure to leverage rather than the bigger guys where they'd just be absorbed."

Then there's Newmont (NEM), the world's second-biggest gold producer. Now subject to daily rumors of a takeover bid from Barrick Mining (ABX), the world No.1, Newmont added 10 million ounces to its reserves in 2006. The company said this week it wants to keep growing reserves at that rate in 2007 and beyond.

"We would like to do more deals than we have done in recent years," says Patrick Highsmith, global manager for exploration business development.

"It can be private placements, joint-exploration alliances and, if assets are for sale, that too."

Assets for sale, of course, have always offered "Route One" to growing gold mining reserves. Non-ferrous exploration hit a record $7.13 billion last year, according to the Metals Economics Group. But merger & acquisition spending in the gold sector alone was nearly three times as much according to analysis by Merrill Lynch.

"It has to be a multi-pronged approach if you're trying to get 10 million ounces of gold a year," says Highsmith. "We're a bigger company now and we need to find new reserves faster.

"We are talking to a lot of juniors."

Taking over a junior - as opposed to talking to a junior - usually means a sharp drop in the combined exploration budget, however. Junior miners accounted for more than half the world's total non-ferrous exploration budgets in 2006, says MEG. But over the last ten years, post-merger budgets the following year have sunk by 20% on average.

If you're looking for the bull market in gold to run beyond the end of 2007 - and Blackstone Merrill Lynch this week forecast that we're only mid-way through a rising commodities market seen once every 50 years - you may be well advised to include physical gold bullion in your portfolio, alongside your gold mining selections.

The rush to find new gold reserves is likely to cut future gold production.


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