November 20, 2023
Gold was up 2.1% to US$1,984/oz, as lower than expected US inflation led once again to market hopes of easier monetary policy, implying lower real yields, a potentially weaker US$ and a rising money supply, which all tend to drive up gold.
Gold rose 2.1% to US$1,984/oz, as US inflation for October 2023 came in lower than expected, driving expectations once again that the Fed would finally be able to shift from rapid monetary tightening to gradual easing. A continued drop in inflation and rates could mean lower real interest rates, a decline in the US$ and a rising money supply, which all tend to propel the gold price. The US equity markets jumped on the news, with the S&P 500 up 2.4%, Nasdaq gaining 2.8% and Russell 2000 index surging 5.8%, as did gold stocks, with the GDX rising 4.3% and GDXJ up 5.3%.
Although headline inflation continues to decline in both the US and Europe, core
inflation has been more persistent, holding at twice the 2.0% targeted by the central
banks for both regions. While US inflation plummeted from an 8.9% high in June 2022
to just 3.2% in October 2023, core inflation was 4.0%, down just 2.6% from a
September 2022 peak at 6.6%. In Europe, headline inflation has dropped from a 10.6%
peak in October 2022 to 2.9% in October 2023, but core inflation is down just 1.5%
from 5.7% in March 2023 to 4.2% in October 2023.
The elevated core inflation has led the US and Europe’s central banks to maintain hawkish tones, indicating that high rates could be maintained for some time, even as headline inflation continues to cool. This, combined with the recent equity market rip, could set up the market for more disappointment, with expectations for soon-to-beless-aggressive central banks having been dashed repeatedly over the past two years. Upbeat periods have been disrupted by economic or political crises which have shaken equity markets but not deterred central banks from their inflation-fighting mission. To the upside, such crises have tended to be good for the gold price.
While the central banks remain cautious, the markets have not been in regards to US
large cap equities, and seem to be pricing in an ideal scenario given very high current
valuations. The S&P 500 price to book ratio (P/B), at 4.3x, is still near its highest in
twenty years after easing from a peak at 4.7x in 2021 (Figure 4). The Nasdaq’s price
to book at 4.8x is also extremely elevated historically, and its multiple tends to vary
much more widely than the S&P 500’s multiple over the cycle.
The Nasdaq P/B rose well above the S&P 500 from 2003 to 2006, although this was as much because of a low book value for the sector, which was still recovering from the dot.com crash, as any rise on the price side. The multiple dropped significantly below the S&P 500 after the 2008 financial crisis and remained under 1.0x until 2013. The move in the P/B above the S&P 500 only occurred very recently, starting in 2021, and the historical trend suggests that the probability for the Nasdaq multiple to revert back towards the S&P 500 multiple is high currently.
In recent years, the jump in the valuations for the Nasdaq and S&P 500 have been driven by the same group of tech stocks. This can be seen in the US sector P/Bs, with US Tech by far the highest at 7.74x, more than three points ahead of the next three highest ratios for consumer discretionary, healthcare and industrials, and well above the other sectors at 2.50x or lower (Figure 5). The Nasdaq and S&P 500 P/Bs of 6.63x and 4.00x are anomalies versus global markets, which all trade below 2.0x, including European, US small cap, emerging market and Japanese stocks (Figure 6).
The gap between US tech and global mining stocks is particularly wide, with the MSCI
Global Metals and Mining ETF (MSCI Global M&M), focused on the megacap stocks
in the sector, at a price to book of 1.50x. The MSCI Global M&M P/B is near the
bottom of the major equity market valuations, almost equal to Japan, and at just a
fifth the level of US tech. There is some justification for the low valuation of the MSCI
Global Metals and Mining ETF, given that it is base metals-heavy and a widely
expected recession could reduce the prices of these already struggling metals further.
These recession concerns are also likely behind the low P/Bs of the copper and silver
miner ETFs just 1.29x and 1.36x, respectively. However, these low valuations raise
the question of how much of the recession fears have already been priced into the
miners, while the sky-high US tech valuations imply the sector would be unscathed.
In contrast to the industrial metals, a potential economic downturn could be good for gold stocks, which could benefit from a flight to safety and return to easier money. This could account for the premium afforded to the gold miners ETF, trading at 1.49x, over the silver and copper ETFs, although this is still near the bottom of global sector valuations. The price to book for gold juniors is just 1.22x, the lowest of any sector covered here, which will partly account for the higher risk of these very small cap companies usually without any revenue. Even so, the market seems to have priced in a large amount of this risk with the sector’s valuations declining to levels not seen since the end of the previous bear market in 2017-2018, and the multiples do not seem to be factoring in a high probability for a further jump in the gold price.
Another indicator showing this valuation divergence between US large caps and other assets is the S&P 500 to gold price ratio. The measure is currently at 2.19x, just below the peak for this cycle of 2.38 in 2021, and up nearly three times from a trough of 0.83 in 2012 (Figure 7). While this is well off the 5.11x peak in 2000, the period from 1998 to 2021 is an anomaly for the series which runs back five decades. If we exclude these years, the current ratio looks very high, showing a market leaning much more towards the risk of the S&P 500 than the relative safety of gold. While the direction for this ratio is unclear heading into 2024, the historical series indicates that the probability for a downtrend is probably higher than for a continued rise.
Yet another indicator backing up the evidence above for unloved gold miners is the Gold Miners Percent Bullish Index, which looks at investment flows to determine the market’s sentiment on the sector. While this measure has ticked up over the past month to 25%, it is still near lows of the past five years, with over 70% reached for an extended period from 2019 and 2020 and in a series of spikes since 2021 (Figure 8). Like the S&P 500 to gold ratio, the series is at such an extreme versus its history that the probability seems weighted more towards a further increase, especially if there is a jump in gold on rising economic and political risks.
Continuing on from the analysis last week of the price to book ratios for the larger TSXV gold and silver stocks, this week TSXV copper stocks are examined. The sector aggregate includes Los Andes, Minsud, Aldebaran, Atex, Sandfire American, Copper Fox and Oroco, all stocks listed since at least 2018 to compare valuations with levels prior to the mining sector boom of 2020-2022 (Figure 9). The largest TSXV copper stock by market cap, NGEx, was only listed in 2019 and is therefore excluded.
The price to book for the group was extremely low in 2018, at just 0.8x, well below the multiples for the large gold and silver TSXV stocks at around 2.0x. However, the multiple rose to 1.7x as the mining sector picked up into 2019, and reached a peak of 3.7x in 2021 (Figure 10). While the multiple declined to 2.9x in 2022, it has remained relatively flat in 2023 at 2.8x, and is still over three times the level of 2018. This contrasts again with the TSXV gold and silver stocks, which have reverted back to 2018 price to book levels of around 2.0x in 2023.
The split of the group’s aggregate equity and market cap is shown in Figures 11 and 12. As discussed last week, some companies capitalize exploration expenses, or have higher cash balances, giving them higher equity bases, and a higher proportion of total equity. Others expense exploration in the period incurred and do not build up an asset, or have low cash, and therefore a lower equity, giving them a lower proportion of the total. These different accounting policies and cash levels can drive major variations in the P/B ratios across the companies, with Sandfire standing out as particularly volatile (Figure 13).
The gold producers were mixed and most large TSXV gold rose as the gold price and equity markets gained (Figures 14, 15). For the TSXV gold companies operating domestically, New Found Gold reported drill results from the Jackpot Zone of Queensway, Osisko Development announced the formation of Electric Elements Mining to explore for lithium, Laurion provided an operational update and Amex reported drill results from the Denise Zone of Perron (Figure 16). For the TSXV gold companies operating internationally, Gabriel Resources and Prime Mining reported Q3/23 results (Figure 17).
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