Gold and the 'Unstoppable' Dollar

Gold continues to slide on hawkish Fed and strong dollar

Gold continued to slide this week, down -0.8% to US$1,723/oz, even briefly dipping below US$1,700/oz, as hawkish comments have continued from several Fed officials and the dollar continued a surge that has been sustained for well over a year.

Backing out what the market is baking in for Artemis's Blackwater

This we look at the market's current valuation of Artemis's Blackwater project, and back out the assumptions that would be required to get to the current share price as well as split the valuation between the four planned phases of the project.

Producers and juniors both down on gold and equity slide

The producers and the juniors were down this week with the GDX off -4.5% and GDXJ shedding -5.3%, and the large cap TSXV junior gold miners were mixed, as the Fed remains hawkish, driving up the dollar and pressuring gold and equity markets.

Gold and the 'Unstoppable' Dollar

Gold was down 0.8% to US$1,723/oz this week, and even dipped briefly below US$1,700/oz for only the second trading day since March 2021, with the previous occurrence on July 20, 2022. This has come as recent comments from Fed officials have maintained a hawkish tone, leading to expectations for a continued tight monetary policy, putting pressure on both gold and equity markets, and also strongly supporting the US dollar. The US$ Index, an average of the value of the dollar versus a basket of currencies, continues to surge, rising from a low of just 90.0 in May 2021 to 109.6 as of September 2022 (Figure 4).

This tends to put pressure on the gold price, given that it is priced in US$, driving an inverse relationship between the two assets, although this is not a hard and fast rule. We can this in Figure 4, with rises in the US$ index generally leading to falls in gold, and vice versa, as shown by the grey bars in the chart, especially from January 2020 to May 2021. However, this relationship is not as clear from June 2021 to around May 2022, when the US$ Index and gold move up in tandem. The expected trend between the two resumes in earnest, however, from June 2022, with the rise in the US$ clearly corresponding to a decline in the gold price.

We see a similar situation historically, with the two generally moving inversely to one other, but with the relationship less clear in some periods, suggesting that it is not a precise tool for forecasting. For most of late 1985 to 1999, the relationship tends to hold, as highlighted in grey, with dips in the US$ tending to propel the gold price, although there are periods, shown in white, where any such trend is less discernible. From 2000 to 2009, there appears to be much less short-term volatility, and much clearer evidence of the theoretical relationship between the US$ and gold, with the dollar index declining for most of the period, and gold clearly rising.

From 2010, volatility resumes, and the expected relationship between gold and US$ holds for most of the period, although from 2012 to 2013 gold plunges even as the dollar remains relatively flat, and from 2018 to 2019 and from May 2021 to May 2022, as shown above, both move up together. Overall, in the roughly thirty-six years shown in Figure 5, the US$ and gold move inversely for about twenty-eight of them, or about 80% of the time, with the relationship less clear only for eight years, or about 20% of the time. Again, not a hard and fast rule, but a reasonably reliable one.

Large and growing interest rate differential propelling US$

The main driver of the inexorable rise of the dollar has been the large and growing interest rate differential between the US versus Europe and Japan, with the other two largest global currencies. Through 2019, US 90-day rates had remained above 1.5%, far above negative interest rates of around a quarter percent in Europe and the near zero interest rate available in Japan (Figure 6). However, with the onset of the globalhealth crisis, US rates nearly converged with the Japanese level, although never actually went negative, and rates in Europe went even more negative, to around half a percent. At that point, the bonds from all three were offering quite unattractive returns to investors, although this was especially the case in Europe.

However, the resurgence of inflation, which hit the US faster and harder than the other regions, although Europes inflation has recently caught up with the US in recent months, drove the spike in 90-day US rates from just 0.06% in December to 2.6% as of August 2022. While both the European and Japanese rates have also risen, they have only just exited negative territory as of the most recently reported data, at 0.04% in July 2022 and 0.01% as of June 2022, respectively. The US rates are obviously far more attractive than these two other regions, and this has driven a major inflow of funds into the US$ chasing these yields.

With both Europe and Japan both also facing a significant jump in inflation, we expect that they eventually will also have to increase rates to bring prices under control. Such increases would likely draw funds back to these regions, and gradually began to push up their currencies versus the US$. However, with the Fed clearly remaining hawkish and looking set to remain on its aggressive rate hike path, it is entirely possible that the spread between US and European and Japanese rates actually continues to widen if these two regions maintain only gradual rate hikes. In this the scenario we could see the ‘unstoppable’ rise of the US$ continue through the rest of 2022.

Producing gold miners down and TSXV juniors mixed

The producing gold miners were mainly down (Figure 7) and the TSXV juniors mixed (Figure 8) as gold and the equity markets declined and the US$ rose. For the producers, Barrick reported that it would sell two royalties portfolios, Alamos reported its Q2/22 dividend and Iamgold filed a final short-form base shelf prospectus (Figure 9). For the Canadian miners operating mainly domestically, New Found Gold, Eskay and Laurion reported drilling results and Tudor an upsizing of its private placement (Figure 10). For the Canadian juniors operating mainly internationally, Lion One reported drill results from a new discovery, Batiri Creek, at Tuvatu (Figure 11).

Start of construction nears for Artemis' Blackwater project

Artemis Gold is on the verge of construction for its Blackwater project, which is targeted for December 2022. With a Definitive Feasibility Study completed in Q3/21, news from the company this year has focused on securing deals with contractors and suppliers for construction and related financing agreements including a process plant EPC, mining fleet and long-lead crushing and grinding equipment. For the rest of the year, the company targets completing a power transmission line EPC contract, its BC Mines Act and Schedule 2 Amendment, and starting construction, with first gold pour targeted by H1/24. The company has the third largest market cap of the large TSXV gold companies at CAD$719mn (Figure 13), given the very large size of its project, with 7.5mn oz Au in expected total production outlined in its Feasibility Study, the second largest of the large TSXV developers (Figure 14), and its advanced stage.

Valuing Blackwater using Feasibility Study assumptions….

In Figure 5 we take a look at the current valuation of Artemis, using the assumptions in the company's Feasibility Study, which shows the potential upside for the Net Asset Value (NAV) of the company. There are four phases of the Blackwater project planned for a 22-year mine life and in our model we have assumed that the initial capital expenditure for the project is incurred over 2023-2024, with full production starting in 2025 (Figure 15). Using mainly the assumptions in the Feasibility Study, altering some items to averages for simplification, arrives at an NAV for the project of CAD$12.2/share, for a Price/NAV of 0.38% given its current share price CAD$4.66, which is similar to the Price/NAV we see outlined by the company in its presentation.

...and backing out the assumptions implied by the market price

We have also then considered a more conservative valuation for the company, using assumptions intended to equate the NAV to the current market price. This allows us to get some general idea of what assumptions are currently being baked in by the market to account for the risk of executing the company's plan over time, especially given its long twenty-two year time line. First we have reduced the total milled ore assumption and the grade, by 5.0% in the first phase, increasing to 15.0% by the fourth phase. We have also reduced the gold and silver price by 10%, and then increased operating costs and capital costs by 10% over the course of the project.

We view these assumptions, especially for the decline in milled ore and grade and the gold and silver price, as quite bearish, given that it would likely take a considerable reduction in the global money supply to head back to US$1,350/oz gold or US$16/oz on average, which we view as unlikely. Given the current rise in inflation, the rise in capital and operating costs seems more probable, but overall we would say that the assumptions baked into Blackwater's current price could certainly not be viewed as overly aggressive and likely better characterized as reasonably conservative.

Valuing Blackwater phase by phase

We can also value each of Blackwater's phases separately to get an idea of how many phases are currently already incorporated into the share price. This requires some changes from the original valuation, especially separating out the capital cost for each phase. In the original model we see a very high capital cost for Phase 1 of $1,031mn, three times the level of Phase 2. This is because in addition to the US$645mn initial start-up cost in 2023 and 2024 leading up to Phase 1, it also includes the US$320mn in initial capex for Phase 2, which actually falls in 2029, before the start of Phase 2 in 2030. There is a similar issue for the capital costs of Phase 3 which starts in 2035, but with initial capital costs landing in 2034.

When valuing the individual Phases, we attribute the capital cost to its own Phase, which changes some numbers, especially taxes, from the original valuations. This also leads to the original valuation not exactly matching the combined valuations of the phases, but it is still useful in showing the rough split between phases. It shows that the share price is incorporating the entire CAD$1.5/share valuation of Phase 1, which is low because of the large upfront capital costs, and the CAD$3.26/share valuation for Phase 2, combining to CAD$4.76/share, or nearly exactly the market price of CAD$4.66/share (Figure 16). Based on this valuation, investors would be getting any upside from Phase 3 or 4 effectively for free. Again, this seems to indicate that the market is not pricing in any particularly aggressive assumptions and overall the valuation for Artemis seems to be reasonably conservative at the current price.

Macro issues could continue to pressure junior gold share prices

The advanced stage and large size main of the Blackwater project, along with its moderate looking valuation, has seen the company avoid much of the carnage of many TSXV large cap gold peers over the past year, with its price down just -11.5%, versus many companies in the sector down well over -30.0%. While Artemis has been hit over the past three months, down -22.5%, we see this coming more from macro issues, part of the overall pressure on equities and gold this year, and gold miners overall not participating in the bear market equity rally of the past few months. Given that we expect the Fed to continue to tighten monetary policy this year, pressure on gold and the equity markets through the rest of 2022 seems likely, and especially on riskier smaller cap sectors like the junior miners. This could continue to pull down the share prices of the TSXV gold miners, even companies with strong company specific fundamentals Artemis.