January 27,2022

Gold Stocks Under Pressure

Gold dips as Fed indicates earlier potential rate hikes

Gold declined -0.7% to US$1,830/oz this week as the Fed indicated an earlier than expected rate hike, possibly by March 2022, well ahead of the expected 2023 hikes, continuing the pressure on equity markets that has persisted through January 2022.

Gold stocks down, but outperforming many other equity sectors

While both producing and junior gold mining stocks are down in the equity rout so far this year, they have actually considerably outperformed most of the major S&P 500 equity sectors, supported by the relatively resilient gold price.

Producers and juniors down, Emerita Resource In Focus

The producing and junior miners slumped, with the GDX down -6.6%, the GDXJ declining -9.4% and the Canadian juniors all fell, as the risk-off sentiment continued, and Spain zinc-copper producer Emerita Resources is In Focus this week.

Producers and juniors down, Emerita Resource In Focus

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Gold Stocks Under Pressure

Gold fell -0.7% to US$1,830/oz this week, as concerns over persistent inflation, and a potentially more-aggressive-than expected Fed reaction put pressure on equity markets and the general risk-off sentiment that has prevailed since the start of this year has continued. The Fed is now talking about raising rates as early as March 2022, where previously no rate hikes had been expected until 2023. While we had not been expecting the Fed to be particularly aggressive this year, given the chance of precipitating a market or economic crash, it now appears more willing to risk this to start combating inflation. While would expect any such rate hike will be very limited in absolute terms, at just 0.25%, with the current base rate at just 0.25%, this would represent a 100% increase in the rate in relative terms. While this would not really be enough to change the actual economics of most assets that much, it could scare the market into viewing the Fed as serious about curbing inflation through rate hikes, which could lead to the pricing in of a series of future rate hikes into current prices.

We have some evidence of a Fed more aggressive than we expected already, with it not softening its stance even with the recent slump in the S&P and actually following this with more aggressive talk. They are starting to sound a bit more like the aggressive early Volcker-led Fed of the 1980s, which boosted the Fed funds rate to over 19% to curb inflation, than the perpetual easy money Greenspan-BernankeYellen Federal Reserve regimes of the 1990s-2010s. However, we do not actually expect the Fed to come through with much more than a couple of 0.25% hikes, given the danger of doing further hikes to the economy and equity markets. Such moves may still not be enough to curb inflation but could still see markets decline considerably.

We expect that the Fed will eventually have to back off hawkish stance

We expect gold itself to continue to hold up reasonably well, unless there is a 2008- 2009 style 'sell everything' crash, where it could get hit briefly, although the ensuing fear and expectation of rate cuts in response would likely eventually drive investors back into gold. While we do acknowledge that a truly aggressive ramp up in rates, which drove down inflation and turned real bonds yield from currently heavily negative to positive, could hit gold significantly, we do not see the Fed truly going through with such a course of action. The damage already done to markets from just indicating a minor rate hike is already clear and continued hawkish messages from the Fed will make it worse. Eventually, we expect that the Fed will be forced to backtrack from political pressure if the markets really start to plummet. However, we expect that even just moderate rate hikes will be enough to drive down the equity markets quite a bit, given their very excessive valuations, and that gold stocks could also take a hit. We have some evidence of how the market is going to react in a continued downturn from the moves in the markets over the past month. Figure 4 shows the performance of gold and other major metals and their ETF performances, compared to the performance of the major sectors of the S&P 500.

Gold once again holding up well in a market decline, as is silver

The first big standout is how well gold has done, rising 1.4% in the decline and outperforming every S&P 500 equity sector except for energy, which was up 17.9% mainly on the rebound in the oil price (for more detail on gold's performance since November 2021 versus almost all major asset classes, see our report last week). The GDX gold producers also held up very well, declining just -1.2%, above even defensive equity sectors like consumer staples, which declined -3.0%, and utilities, down -6.0%. Defensive equity sectors like these tend to be sold off less in crashes, and gain less in market rises, as demand for their products tend to be more stable over time. More cyclical sectors are down, including a -12.7% drop in consumer discretionary, which includes luxury items that consumers tend to pullback on during economic downturns. Other sectors taking a major hit are Information Technology, including stocks like Apple and Microsoft, down -13.1%, and the Communications Services sector, down -10.7%, including Alphabet (Google) and Metaverse (Facebook). These sectors are full of riskier tech stocks, which are seeing strong revenue growth, but with many still having no earnings, and trading at extremely high valuations, which has driven investors to sell them off the most aggressively.

Gold once again holding up well in a market decline, as is silver

Silver gains up but its ETFs decline, copper flat but its ETF rises

Silver has seen stronger gains than gold, up 2.4%, suggesting that it may being driven by; 1) inflation, given that it is affected by monetary factors, similar to gold, although also by industrial factors, more like copper, with the former seeming to be the main factor so far this year, and 2) its ratio relative to gold is historically somewhat low, and it could be closing that gap. There has been some interesting movement in the silver ETFs, with the riskier silver juniors ETF down just -1.3%, but the silver producers ETF down by -3.9%, when we might expect the reverse to be case if investors are selling off riskier assets more aggressively. We are also seeing strength in the copper miners ETF, which is up by 3.4%, even though the copper price was near flat, down -0.3%. If the general idea of the recent market move is that the Fed rate hikes might cause a pullback in the economy overall, we might have expected to see the copper miners ETF decline by as much as the silver ETFs, if not more.

Lithium and uranium ETFs see significant decline

Two metals ETFs that have been hit very hard in the market correction are the Lithium and Battery Metals ETF, down -8.1, and the Uranium Miners ETF, down -8.8%. These had been two sectors that been quite 'hyped' in 2021, with lithium propelled by a major push of the green technology last year and investors moving aggressively into the story. Uranium was boosted especially by the creation of a large physical uranium ETF by Sprott that was aggressively buying up the metal. It seems that the hype may have pushed the valuations of the metals and companies underlying these ETFs a bit ahead of themselves, as a market looking to sell off the most overvalued stories it can find has also put the lithium and uranium stories in this category.

Investors seem content to keep holding gold

Overall, investors seem content to keep holding gold, and are paring their gold stock holdings moderately compared to other sectors, and even the more risky juniors are getting sold down less than several S&P 500 sectors that are considered defensive, and certainly less risky overall than junior gold miners. Silver has also held up, and although its producing and junior ETFs are down more than the corresponding gold ETFs, they are still well above the performance of most of the S&P 500 equity sectors.

While the copper miners ETF has outperformed both those of gold and silver, with the underlying metal's performance lower than both, we question how sustainable this may be. Overall, so far in the market decline this year, which we expect is very likely to continue for some time, the market has made a vote in favor of precious metals, and we expect that this will continue, with inflation likely to remain high, even with more-aggressive-than-expected Fed rate hikes, and fear in markets also rising, driving investors into the relatively safety of gold and silver.

Investors seem content to keep holding gold

Producers decline as equity markets fall

The producing gold miners were all down as equity markets continued to see significant pressure as the US Fed indicated that it may increase interest rates as soon as March 2021, much earlier than the 2023 hikes originally expected (Figure 5). Barrick reported FY21 production from its Kibali gold mine in the DRC and its North Mara and Bulyanhu mines in Tanzania. Pretium reported that its acquisition by Newcrest has been approved at its special shareholder's meeting, Equinox released its 2022 production guidance and Iamgold is tracking the political situation in Burkina Faso, although its Essakane mine has not been affected (Figure 7).

Canadian juniors down in risk-off sentiment
The Canadian juniors all declined as a general risk-off sentiment continued in markets (Figure 6). For the Canadian juniors operating mainly domestically, Great Bear filed a management information circular and materials for its special meeting of shareholders related to the planned acquisition by Kinross. New Found Gold reported drill results from the Keats footwall zone at Queensway, Osisko Development announced that it would acquire Tintic, which operates the Trixie mine, which had a recent ultra-high grade discovery, and Probe Metals reported drill results from expansion drilling at the Monique gold zones at Val-d'Or East (Figure 8). For the Canadian juniors operating mainly internationally, Rupert Resources reported its financial results for the November 2021 quarter, Arizona Metals released drilling results from the Kay mine, Novo Resources reported drill results from the ParnellVulture trend, and Lion One released drill results from the infill drill program at Tuvatu (Figure 9).

Producers decline as equity markets fall

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In Focus: Emerita Resources (EMO.V)

In Focus: Emerita Resources (EMO.V)

Zinc-copper explorer in Spain

Emerita is a zinc-copper explorer in Spain which has three major projects; 1) the Iberian Belt West (IBW) project, which has two high-grade zinc-copper-lead-silver deposits, Romanera and La Infanta, 2) the Aznalcollar zinc deposit, with a historical resource of 20 Mt grading 10% zinc and lead which is open for expansion, on which Emerita did extensive work in the tender process. There is an ongoing court case for this project regarding other competing bidders, with the other parties expected to be eliminated because of criminal issues and the company to take ownership, and 3) the Plaza Norte, a joint venture with Aldesa for exploration concessions of 3,600 h.a. .

Gains on IBW drill results, Aznalcollar court case and copper price

Emerita saw a series of drivers over the past year. For the first half of the year, strong gains were driven by exploration at IBW, with a diamond drill program, coupled with the pickup in the copper price. Outstanding drilling results released in H2/21 drove a further ramp up in the share price, including 3.8% Cu, 30.5% Zn, 15.6% Pb and 372 g/t Ag over 5 m in and 3.6% Cu, 27.8% Zn, 15.1% Pb and 319 g/t Ag over 11.1 m in August 2021. Another driver in October 2021 was a decision regarding the Aznalcollar project which indicated the elimination of some other bidders on the project for criminal reasons, likely leaving Emerita as the only qualified bidder.

Strongest performer of the largest TSXV copper explorers

The company is the largest of the TSXV copper explorers, at $592mn, and by far the strongest performer of the group, up 1588% over the past year (Figures 11, 12). This has driven up Emerita's price to book to 75.9x, although, similar to NGEx, the company has a very low equity which makes the ratio distorted. However, it still demonstrates the increased market interest in the company, with its P/B at 5.3x at the end of 2020 (Figure 13). Even after the large ramp up, the company still has 43% upside to its consensus target price, although given the recent slump in equity markets, we suspect that many target prices will currently be under review.

Strongest performer of the largest TSXV copper explorers

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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.

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