February 18, 2022
The gold price rose 2.0% to US$1,872/oz this week, heading towards the top of a trading range between about US$1,700/oz and US$1,900/oz that has held since the start of 2021 as the market seems to be doubting the Fed's ability to control inflation.
This week we track the flight path of the TSXV-listed gold juniors so far in 2022, with many of the larger and mid-cap names having returned to break even or above in a February recovery after a difficult January when equity markets were under pressure.
Gold rose 2.0% to US$1,872/oz this week, and looks like it could be starting to
breakout of a range from around US$1,700/oz to US$1,900/oz that it has held since
2021 (Figure 4). We believe that this may be indicating a shift in the market's
perception of how much the Fed will be able to keep inflation under control. For most
of the second half of last year, the market conception seems to have been that while
inflation was rising, it was transitory, and that by early 2022 we should have seen it
trending down. Clearly the data is showing that this is not the case, and inflation is
actually reaching a dangerous point where economic actors may start baking in
persistently high inflation into their decisions.
In Figure 5, we can see that US CPI inflation had been remarkably low from 1983 to 2020, and therefore not really an issue for nearly forty years, making it understandable that until the past few months, it was not really a major concern for markets (Figure 5). That this lack of fear of an extended period of high inflation persisted for decades prevented some dangerous developments, including especially a wage price spiral. This is where workers anticipate higher prices and therefore demand higher wages, driving businesses in turn to raise prices to maintain their margins, and these higher prices in turn drive workers to demand another round of wage hikes. Such a situation has not really occurred for about four decades in most developed countries but was a feature of their economies especially through the 1970s and into the 1980s.
If inflation indeed had been transitory early this year, the markets would have likely
returned to their low inflation expectations of the past four decades. They may have
assumed that it was mainly just the distortions from the post-global-health-crisis
fallout, including major supply chain disruptions, that was driving the higher prices,
and that these were only temporary, and not indicating a longer-term surge in inflation.
However, we believe that it is more the massive of tsunami of money that was unleashed by central banks during the crisis, and especially the US Fed, that has really driven this problem, and that without this huge wave of liquidity, that the current inflation would not be occurring (Figure 6). While the peak of US M3 money supply growth is now a year behind us, in February 2021 at 27.1%, and it has come down significantly since, it is still extremely high in historical terms, at 13.1% December 2021. Looking at the peaks in US M3 money supply growth since 1960, anything above 10% year on year could be considered excessive, and the current rate of money supply growth was only surpassed two times, during the global health crisis last year and in the 1970s, when it peaked at 13.5% in January 1977. This puts in context just how massive the monetary expansion really was during the global crisis health crisis and could certainly be considered out of control in a historical context.
It is understandable that the Fed believed it could perpetually increase the money supply at high rates without driving up inflation, as it had done so through much of the past two decades, and especially following the financial crisis of 2008-2009 when even though the money supply surged there was still considerable deflation. US M3 money supply growth also remained high after the financial crisis and yet inflation remained remarkably low. An active reduction in the level of money supply growth through 2017 started to cause volatility in stock markets by 2018, and money supply growth was once again expanded through 2019, but inflation still remained low. We are seeing a similar scenario to 2017 now, with even just the mention by the Fed that it will start some minor rate hikes already driving substantial equity market declines.
However, in distinct contrast to 2017, the Fed is now face surging inflation, and given their mandate to keep inflation below 2.0%, they are now far behind the curve, with US CPI inflation heading for four times that level. While for the last forty years, low inflation had allowed the Fed to concentrate on the second half of their mandate, to promote growth, controlling rising prices will now likely be starting to take precedence. However, the Fed is in a difficult spot, as raising rates aggressively could have at least three major effects. First, it could curb overall economic growth as businesses may pull back on investment and households reduce borrowing as interest rates rise. Second it could cause a further decline in equity markets, with rising rates increasing discount rates and reducing equity values, which could be exacerbated by extremely high valuations currently. Third, it will increase the interest burden on the US Federal government, with US 10-year bond yields having nearly doubled over the past year, from 1.17% in August 2021 to around 2.00% currently, driving an increase in the cost of borrowing. US government debt has also surged since the global health crisis, from just above 100% of GDP from 2012 to 2019, to over 120% of GDP, making the overall debt service even more onerous (Figure 7).
The market will have a certain weighting for all of the scenarios above, as well as the counter arguments against them. These counter arguments could include that inflation still does prove to be transitory, only a bit later than we expected, with Fed rate hikes seeing inflation start to ease by mid-2022, while economic growth remains robust, in contrast to our expectation that we could see growth slow. What we would suggest is that the market is starting to attribute a lower weight to the probability of a transitory inflation/strong growth scenario, and a higher one to a continued high inflation/easing growth scenario, thus driving the pickup in gold. We believe that the weighting for a continued high inflation/easing growth scenario will be at least maintained this year and could conceivably increase as this year continues.
This week we look at the flight path of the top TSXV gold companies since the start of 2022 to show how the stocks are performing through the big surge in volatility, in the context of their market caps, split by large, mid and smaller cap companies and their valuations, using price to book. There have been two main trends so far this year, the first being the decline through January 2022 because of the overall downtrend in equity markets, while gold held up reasonably well, and the second has been the rebound in gold stocks as the gold price has surged so far in February. For the large caps, developer Osisko has had the best performance, up 10%, with its very low valuation of 1.3x price to book truncating its downside, with Great Bear holding flat this year based on the Kinross acquisition offer (Figure 8). Explorer Arizona Metals, with a high P/B of 28.5x, and developer Artemis, with a low P/B of 2.5x have returned to roughly flat after considerable dips earlier in the year. Explorer Rupert, with a moderate 8.9x P/B has dipped about 4%, and New Found Gold with a P/B of 13.7x, near the acquisition-driven multiple of Great Bear, is down about 10%.
The mid cap TSXV gold companies have seen more gainers, with explorer Eskay, with a high 36.1x P/B multiple, up 8%, developer Orezone, with a moderately high 6.1x P/B, up 7%, and explorer Tudor, with a similar multiple of 5.8x, and producer Pure Gold, trading at low 3.7x, up about 3% each (Figure 9). Explorer Prime Mining, trading at a reasonably high 9.7x P/B, is down about 7%, as is developer Bluestone, trading at a low P/B of just 3.8x. The smaller cap names have not recovered as quickly as the larger and mid-caps, with only explorer Amex rising, up 3%, and trading at a moderate 4.4x P/B. Both producer Mako, trading a 7.8x P/B, and developer Chesapeake, trading at just 1.2x, are down about 8%. Developer Lumina Gold, trading at a high 27.4x P/B, is down 11%, and explorer Novo Resources is the worst performer, down 21%, and now trades at the lowest P/B of the group, at just 0.8x.
The producing gold miners were all up on the jump in the gold price (Figure 11). Barrick started off the Q4/21 results season as the first major company to report, with gold production for the quarter down -0.2% yoy, revenue up 0.9% and net income up 17.9%. Agnico Eagle reported drill results from the Detour Mine Trend at Detour Lake and Yamana updated its mineral reserves and resources estimate for 2021 with replacement achieved at each of its wholly owned operations. Lundin Gold reported an update on its completed 2021 regional exploration drilling and its 2022 program and Iamgold reached an agreement with Resource Capital Fund for the appointment of three new members to the Board of Directors, with three members of the Board of Directors to leave the company (Figure 13).
The Canadian juniors were nearly all up on the rise in gold, with only two names seeing moderate declines (Figure 12). For the Canadian juniors operating mainly domestically, Great Bear reported that its acquisition by Kinross had been approved by its shareholders on Feb 14, 2022. Osisko Development reported an upsizing of its bought deal private placement to US$90mn, Pure Gold announced the closing of its $14.0mn bought deal private placement and its $17.2mn non-brokered private placement to AngloGold, and Probe Metals reported a private placement of $20.8mn. (Figure 14). For the Canadian juniors operating mainly internationally, Chesapeake reported results from infill drilling at Metates and Integra Resources released its PreFeasibility Study for Delamar, with an after-tax NPV of US$412mn at a US$1,700/oz gold price and US$21.5/oz silver price (Figure 15).
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.