May 28,2021

Gold continues to rise on inflation fears

Gold at highest levels in five months

The gold price rose 0.9% this week to US$1,899/oz, its highest since January 2021, on inflation concerns, and even as the Fed has started 'taper talk' we believe it may have trouble in reducing its assets without some major economic disruptions.

A look at mid-tier TSX North America gold producers, developers

This week we provide an outline of the projects and Resources of the mid-tier TSXlisted North America gold producers and developers and their relative valuations on an EV/Resource basis and the upside to their consensus target prices.

Producers and juniors under pressure even as gold rises

The producers were down as the GDX fell -0.8%, the juniors were near flat with the GDXJ rising 0.1%, and the Canadian juniors were mixed as fears of inflation driving a decline in equity markets, including gold stocks, outweighed the rise in gold.

Producers and juniors under pressure even as gold rises

Figure 4

Figure 1

1) Fed Taper Talk and Markets Partying Like its 1999

Gold was up 0.9% this week to US$1,899/oz, its highest level since January 2021, and briefly edged above US$1,900/oz, as inflation concerns continue after the shock US consumer price inflation of 4.2% for April 2021 (Figure 4). The US Fed, which has a mandate to keep inflation under control through interest rate hikes, has played this down so far, suggesting that it is temporary. Yet at the same time, there have been early hints of 'taper talk' from the Fed, that it would start to reduce bond purchases by 2022 and raise rates by 2023. The Fed views the high CPI number as the combined effect of; 1) a low base from April 2020, when the CPI Index dropped because of the crisis, and 2) supply constraints, with the global crisis causing broad shutdowns across industry and reducing supply, but demand unexpectedly surging, driving up prices. The Fed expects that once supply chains are back to normal, the inflation should subside.

1) Fed Taper Talk and Markets Partying Like its 1999

While we might agree with these conclusions if the underlying monetary situation were normal, we believe that the global monetary tsunami of the past year will more than offset the CPI base effect and any return to normalcy for supply chains. And as for the 'taper talk', we can see that the Fed has expanded its balance sheet so dramatically, that at this point, it would be difficult for them to exit their position without some serious disruption to the global economy and debt and equity markets (Figure 5). In percentage terms, the increase in the Fed's balance in this crisis is actually less than that during the global financial crisis of 2008-2009, with assets rising 90% from February 2020 to May 2021, and rising 134% from September 2008 to January 2009. So we could say that this crisis has been moderately less extreme than the 2008-2009 crisis, but still very severe.

Figure 3

However, to see how much the Fed has extended itself, beyond this percentage change in assets, we should also consider Fed assets to GDP to get an idea of relative expansion in the Fed balance sheet versus the economy. Doing this we can see that the idea floated in 2009-2009 that the Fed would be able to reduce its assets over time, either in absolute terms, or relative to GDP, has not really proved true. Fed assets to GDP shot up from just 6.2% in 2007 to 15.2% in 2008, and did not decline, and was at 19.2% in 2019 just before shooting up to 34.9% in the crisis (Figure 6). This leads to the question, when will the Fed really be able to reduce its balance sheet, how long would this take, and how disruptive will it be? There is no evidence that this would be easy, as given the past decade since the financial crisis, the Fed had a concerted push to reduce its assets only for a brief period in 2018-2019.

Figure 4

Equity market valuations are at very high levels historically

We might believe more in the Fed's ability to extricate itself from the heavy asset load it is carrying if we had an economy and equity and debt markets coming out of an extended trough where much of the boom time excesses had been fully worked out, putting the economy on a more solid base. From such a start, a fundamental underlying pickup could probably support some inflation, as sign of a genuine pickup in economic activity, and the Fed would have the flexibility to raise rates and reduce its balance sheet in this case. However, we are quite far from a bottom, and instead, the economy has been propped up by an epic tsunami of monetary expansion and related bond issuance, lowering bond prices, and leading to spiking yields.

This has effectively crashed the bond markets already, and any attempts by the Fed to sell off the bonds it holds would only worsen this situation, likely sending rates soaring even higher. Meanwhile, these types of jumps in rates can hit equity markets quite hard, which is why the inflation jump spooked the stock market in May. Again, were the markets in the early stages of a pick-up and at relatively low valuations, this might not be such a problem, with the equity markets with some capacity to absorb rising inflation and rates. But the markets are not at all in the early stage of pick-up now, and valuations have shot up to levels only seen in extremely excessive periods, followed by crises, 1999-2001 and 2008-2009.

The trailing PE for the S&P 500 has spiked to 44.5x, or around 1999-2001 dot.comera levels, and nearly three times the long-term average trailing PE of 16.1x. The S&P Price to book and US market capitalization to GDP (one of Warren Buffett's favorite indicators for market over or undervaluation), at 4.52x and 2.17x, respectively, are also back up to levels near the excesses of 1999. While we admit that the monetary tsunami could still push these valuations further, we are very clearly closer to the top of the market than the bottom. In this case, any move the Fed makes leading to higher rates is quite risky, as it could pop the stock bubble and send markets crashing.

Equity market valuations are at very high levels historically

Figure 2

So how does all of this effect gold and gold stocks?

So what does all this mean for gold and the gold producers and explorers? Well, first, we expect that the Fed will hold off as long as it can on both tapering and rate hikes, and inflation is likely to remain relatively high for 2021, and this should be good for gold this year. If inflation really spikes, this should propel gold quite strongly at first, but also likely force the Fed to intervene with quite major rate hikes, which could send gold down temporarily. However, such rate hikes could crash markets, and gold could benefit from a flight to safety. We could also see moderately high inflation over an extended period, but not enough to trigger big rate hikes, probably the ideal scenario for gold, which would continue to rise gradually.

For gold stocks, a major sudden rate hike in response to soaring inflation would likely hit their share prices, which would be pulled down in a likely indiscriminate sell off in the stock markets, and in a heavy risk-off environment, the juniors could be hit even more given their higher levels of risk. This is what we saw in March 2020, with gold holding up well, but the larger cap gold miners ETF GDX declining and the junior explorers ETF the GDXJ plunging even more severely. So for gold stocks also, a period of gradual rising inflation would likely be the best outcome. However, we also need to consider the cost side, with rising inflation driving up costs for gold miners, although we expect that the gold price will tend to outpace costs in general in an inflationary environment.

2) TSX North American Producers, Developers

This week we take a look at the TSX-listed mid-tier gold producers and developers with entirely North American operations, with a market caps ranging from $1,566mn to $478mn, as shown in Figure 9, with most having operations in Canada and only one, Perpetua, with operations in the US. There are two companies which have reached the production stage, Wesdome and Victoria Gold, two companies at the PEA stage, Osisko and Skeena, two projects at the Feasibility Stage, Sabina and Perpetua, and one at the Pre-Feasibility Stage, Marathon. Wallbridge is at the earliest stage of the group, still drilling without having released a mineral resource yet.

2) TSX North American Producers, Developers

The best performer of the group has been Skeena Resources, up 250% over the past year (Figure 10), on a series of strong drilling results at Eskay Creek, the start of a Pre-Feasibility Study for the project in June 2020, a maiden mineral resource released at Snip in July 2020, and a substantial cash balance. The company has 5,569k oz Au, around the average of the group (Figure 11), has an EV/Resource of $149/oz, below the average of the group at $215/oz (Figure 12), and an upside of 54% to its current target price (Figure 13), suggesting that the market still sees considerable upside for the stock even after its big run, as it now has two advanced projects, and a reasonably large resource.

The second-best performer has been Victoria Gold, up 115%, with its Eagle mine just about to reach its first full year of commercial production, with 116.64k oz produced in 2020, a major drilling program at its newer exploration project Raven planned for this year, and while it reported a relatively light EBITDA in Q1/21 the company expects H1/21 production to be weighted more to Q2/21. It has a low level of resources versus the group, at 3,267k oz Au, but trades at the highest EV/Resource, at $408/oz, and is nearing its market target price, with only 17% upside. This is because as it has entered production, the market is clear on the long-term prospects for Eagle, and the main drivers will need to be either a further gain in the gold price, or successful results from the Raven drilling campaign.

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Figure 2

The next best performer has been Marathon, up 91%, which operates the Valentine Gold project, which had a Pre-Feasibility Study released in 2020 and a Feasibility Study is currently being undertaken along with an Environmental Assessment expected to be completed this year. The company has 4,777k oz Au in Resources and trades at a relatively low EV/Resource versus the group of $125/oz, and has 33% upside to its target price.

The fourth best performer is Perpetua, up 59%, operating the Stibnite project, a legacy restoration of an existing mine, producing mainly gold, but also antimony, which is rare in the US, with 10,800k oz Au resources. A Feasibility Study was released in December 2020 and the company is in the permitting process, with an Environmental Impact Statement targeted for Q3/21 and further permitting in 2021- 2022. The company is valued at the second lowest EV/Resource of the group, at $45/oz, but has the highest upside of the group to its target price, at 167%.

Figure 3

Figure 4

The largest company in the group, Wesdome, up 1% over the past year, has three advanced projects, Eagle River, in production, Kiena with a PEA in 2020 and PFS expected by 2021, and Moss Lake, with a PEA. It has Resources of 5,624k oz Au, around the group average, an EV/Resource of $269/oz, above the group average, and an upside to its share price of 23%

The rest of the group has seen declines over the past year, including Osisko, down -4%. It has reasonably large Resources of 6,137k oz Au, and operates Windfall project where it continues to drill at the Lynx targets. The company is valued just below the group on EV/Resource, at $165/oz, and its price has been quite flat. However, as it has a decent-sized resource, is cashed-up after a February bought deal placement, and continues to move forward on Windfall with a Feasibility study target by H1/22, and the market sees a substantial 90% upside to the target price.

Developer of the Goose Gold Mine, Sabina, is down -20%, although the project is fully-permitted and the company is in the early stages of mine construction. It has by far the largest resources of the group, at 12,765k oz Au, but the lowest EV/Resource, at $45/oz, and the market sees the company as undervalued, with a substantial 126% upside to its target price, the second highest of the group. Operator of the Fenelon gold project Wallbridge, is at the earliest stage of the group, with an ongoing drill program but no maiden resource estimate yet, has declined -32%. The company has the smallest resources of the group at 1,227k oz Au, and trades at an EV/Resource of $340/oz, above the average, and the market sees upside of 94% to the target price.

Figure 1

Producers mixed even as gold is up

The major gold producers were mixed this week even as gold picked up, as some investors may still be concerned that rising inflation could pressure equity markets, including gold stocks. (Figure 14). News flows included B2Gold providing an update on the Fekola Mine in Mali, which is not expected to see major effects from ongoing political changes in the country and Centerra reported on issues in the Kyrgyz Republic where the Kumtor Mine has been seized by the government (Figure 16).

Producers mixed even as gold is up

Figure 3

Canadian juniors mixed

The Canadian juniors were mixed this week even as gold rose (Figure 15). For the Canadian juniors operating domestically, Victoria reported the start of exploration at the Raven target at Dublin Gulch, Great Bear is nearing the completion of maiden resource estimation drilling of the LP Fault and Artemis closed the bought deal offering component of its ongoing financing. New Found Gold reported assays from Keats, Tudor Gold reported the start of a 30,000 m exploration program at the Goldstorm deposit at Treaty Creek, Amex Exploration reported results from definition drilling of the High Grade Zone of the Eastern Zone of Perron and Galway Metals reported the first drill results of the 10,000 m 2021 program at Estrades (Figure 17). For the Canadian juniors operating mainly internationally, Novo signed a 3-year agreement with Intertek Testing Services for the planned infill drilling at Beaton's Creek, Chesapeake reported the completion of its 2,500 m diamond drilling program and Orezone is moving toward finalizing documentation on a debt package. Mako Mining provided an operation update on San Albino, Lion One announced drill intercepts from Tuvatu and Gabriel reported its Q1/21 results, with the focus still on the arbitration with Romania regarding the Rosia Montana mine (Figure 18).

Canadian juniors mixed

Disclaimer: This report is for informational use only and should not be used an alternative to the financial and legal advice of a qualified professional in business planning and investment. We do not represent that forecasts in this report will lead to a specific outcome or result, and are not liable in the event of any business action taken in whole or in part as a result of the contents of this report.