December 19, 2022
Gold was down -0.5% to US$1,790/oz and equity markets pulled back in a broadly bearish week with rate hikes from the Fed and ECB and the heads of both central banks taking hawkish tones, indicating that the fight against inflation is far from over.
This week we look at the 2020-2022 lithium price surge and the potential that it may have peaked given recent pullbacks, with some analysts expecting lower EV demand on a slowing economy while new lithium supply comes online in 2023.
The producing and junior gold miners dropped, with the GDX falling -1.6% and GDXJ down -1.3% and larger cap TSXV gold stocks were mixed as equity markets declined as hopes earlier this month of a more dovish outlook from central banks were dashed.
Gold declined -0.5% to US$1,790/oz, after reaching US$1,814/oz mid-week, its highest level since June 2022, as both the US Federal Reserve and the European Central Bank (ECB) hiked rates in their continued fight against inflation, driving down equity markets. While the rate hikes were largely expected, what really hit the markets were the hawkish tones of the head of both the Fed and the ECB, outlining that rates would continue to rise heading into 2023, and be maintained at high levels for an extended period. The market had likely been hoping for at least moderately more dovish language from these Central Banks that their currently aggressive stance was being reconsidered.
Both the Fed and ECB hiked 50 bps, increasing the Fed Funds Effective Rate to 4.3%
and ECB Deposit Facility Rate to 2.0%, putting both rates at their highest levels since
the first half of 2008, just prior to the global financial crisis (Figure 4). This is because
both regions, as well as the rest of the world, are still battling surging inflation. US
inflation was at 7.12% in November 2022, and while down off its June 2022 peak, is
still at forty-year highs, and ECB inflation is even more severe, having peaked at 10.62%
in October 2022 and only eased to 10.05% as of November 2022 (Figure 5).
Historically in periods of high inflation, interest rates have had to meet or surpass inflation levels to truly quash actual price increases, and perhaps more importantly, market expectations for continued rising prices. This would suggest that at current rates of inflation over 7.0%, that the Fed may even have to go farther than the 5.25% that is currently targeted by the market as the peak Fed Funds Effective rate in mid2023. Both of these major central banks are well aware that once the 'inflation genie' gets out of the bottle, it can be difficult to control, as economic actors all come to expect inflation and start to bake it into their economic decisions.
Persistent inflation that is not aggressively dealt with by central banks can develop into wage-price spiral where workers anticipating further price increases start to demand higher wages to keep up with rising prices. Companies in turn hike prices to maintain margins, and workers counter with even higher wage demands. The cycle ends with either a major recession slashing demand and prices, or in rare cases with hyperinflation. Given the choice between runaway inflation and a recession, the central banks prefer the latter, and this explains their current stance. Both the US and EU are seeing quite strong jobs markets and increasing wages, which along with the current high CPI inflation, are tinder that could help ignite a wage price spiral. There is a similar situation across most major develop markets, and all seem to be erring on the side of caution with their rate hikes, with the main exception being China, which already had relatively high rates at the start of 2022 (Figure 6).
For gold, the current action of central banks could mean rising real rates as nominal yields rise and inflation falls, which might pressure gold. However, this could be offset by a move into gold as a risk hedge, which may mean another year of gold holding at around US$1,800/oz in 2023. For gold stocks, while a steady gold price would be supportive, a recession and extended period of high rates will pressure the equity market overall, and could drag down gold stock valuations along with it. However, we would not yet rule out inflation surprising to the upside combined with a recession, resulting in stagflation, which could drive up gold so much that gold stocks actually also rise, or at least outperform the overall equity market.
While there has been some recovery in metals prices over the past two months, most are still down since roughly the peak of the boom around April 2022. The precious metals have fared relatively well, with silver down just -4.0% and gold down -7.0%, while aluminum is 26% off its early April 2022 levels and iron ore down 28% (Figure 7). The 'last man standing' in the metals market remains lithium, which is still up 15% since April 2022, after a metoric 1,022% gain in its average price to 496k CNY/tonne in 2022, up from an average 44k CNY/tonne in 2020 (Figure 8).
However, some analysts are starting to become concerned that this surge in the lithium price may be faltering. This is based on expectations that demand for electric vehicles, the batteries for which comprise in turn the main demand for lithium, could decline on a potential economic slowdown and because of rising EV prices. Major new lithium supply is also expected to come online by mid-2023, which will offset some of the severe supply constraints that the industry has faced in 2021-2022.
There was already a pullback in lithium from April 2022 to May 2022, along with the
broader decline in metals prices, but this was moderate compared to other metals,
down just -6.0%. The price then remained relatively flat until a pickup from late
September 2022 to early November 2022, but it has faced another -6.0% decline
since, raising questions whether it has passed, or is near its peak. While the new
supply expected to come online will be a major driver in determining this, this factor
will be relatively fixed, with a long lead time needed to develop new lithium capacity
and less room to shock to the up or downside.
However, electric vehicle demand could have more abrupt unexpected moves depending on the economic situation. While overall electric vehicle sales remain strong, there are signs that the pace of the huge wave of growth over the past three years, from just 148k units in January 2020 to a peak at 1,040k units in September 2022, is waning (Figure 9). Growth in EV sales in China, the main source of global EV demand, which peaked at 627% yoy in February 2021, has consistently trended down since, and is now at just 67% as of October 2022, while sales to the rest of the world have declined from 379% growth in April 2021 to 44% in October 2022.
While of course these recent EV sales growth numbers are hardly weak, they could be reaching levels where the supply side can start to catch up, which was impossible in the sudden surge of demand especially in 2021. Some analysts believe that current capacity expansion in reaction to this demand could even lead to an oversupply of lithium in some segments of the market. There is also the potential for a recession to develop in 2023 that leads consumers to pullback suddenly on big ticket items like new auto purchases, which could potentially see EV sales, along with all global auto sales, plunge. This could drive a considerable decline in the price of lithium.
The larger TSXV lithium stocks have certainly not all benefited by the rise in the lithium price, with only Sigma Lithium and Critical Elements seeing substantial market cap gains this year, based more on company specific developments than the lithium price gains (Figure 10). Many of the group saw declines even in the first half of 2022 when lithium was still rising rapidly and several saw significant gains in the second half of the year, even as the lithium price started to stagnate (Figure 11).
The producing gold miners and TSXV junior gold miners were mixed as gold eased
and the equity markets declined (Figures 12, 13). For the producing miners, Barrick's
subsidiary Nevada Gold Mines commenced construction of the TS Solar Facility and
completed the reconstitution of the Reko Diq project in Pakistan after receiving a
favorable opinion from the country's Supreme Court. B2Gold announced production
guidance and drill results from the Fekola Complex in Mali, SSR Mining reported drill
results from the Seabee property and Eldorado reported its subsidiary Hellas Gold in
Greece entered into a EUR680mn project financing facility expected to cover 80% of
the cost of the Skouries project, with the remainder to be funded by Eldorado's cash
and cash flow (Figure 14).
For the Canadian juniors operating mainly domestically, New Found Gold closed its C$50mn in bought deal financing including participation from Mr. Eric Sprott, who maintained a 19% stake in the company. Tudor Gold reported a review of its 2021 and 2022 drill programs at Treaty Creek, Probe Metals reported drill results from the Monique Zone of the Val-D'Or East project and Eskay reported drill results from new discoveries in the TV-Jeff corridor (Figure 15). For the Canadian juniors operating mainly internationally, Rupert Resources started trading on the Toronto Stock Exchange, graduating from the TSXV, under the same ticker, RUP (Figure 16).
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.