November 13, 2023
Gold was down -2.9% to US$1,943/oz, declining for a second week, as a move into US large cap equity continued even as Fed Chairman Powell came out with hawkish comments in a speech and Moody’s downgraded the outlook for US debt to negative.
This week we look at the aggregate price to book valuations of the large cap TSXV gold and silver companies, which after surging from 2019 to 2021 have dropped over the past two years back to around the pre-boom levels of 2017 to 2018.
Gold was down -2.9% to US$1,943/oz, declining for a second week as the risk-on
move into US large cap equity continued with the S&P 500 and Nasdaq up 2.10%
and 1.56%, respectively. Even hawkish comments from Fed Chairman Powell, and
Moody’s downgrade of the US debt outlook did not curb large cap buying, which
ramped at the end of the week. However, the charge into equities did not include US
small caps, with the Russell 2000 slumping -3.12%, which along with the gold price
decline dragged down the gold stocks, with the GDX losing -7.5% and GDX -7.4%.
The rise in US equities was driven by the largest tech stocks, with Apple, Microsoft, Alphabet, Amazon, Meta and Nvidia jumping 5.63%, 4.61%, 2.70%, 3.41%, 4.12% and 6.65%, respectively. Last week we showed how much the Nasdaq and S&P 500’s gains this year have been concentrated in just a few megacap tech stocks with elevated valuations. We also questioned the sustainability of this trend, given the very different picture shown by most other assets, with US small caps, global equities, bonds and commodities either just eking out gains or making considerable losses. If these megacaps plunge, they would likely take down S&P 500 and Nasdaq with them, and could precipitate a negative spiral for other assets which are already struggling.
In light of this performance and valuation divergence between megacap US tech and other assets, this week we see how TSXV larger cap gold and silver valuations have fared in a context of struggling small caps, a rising gold price and near flat silver price. The overall trend is a slide from a peak in 2020, with valuations slumping to the preboom levels of 2017-2018. While this suggests that TSXV gold and silver valuations could hardly be considered excessive, it is still questionable whether a bottom has been reached, and both a strong bull and bear case can be made for 2024.
To be able to compare like for like valuations over time, we use an aggregate price to book of TSXV gold and silver stocks that have been listed for several years. For the gold this comprises twelve of the largest TSXV market cap companies; Reunion, Robex, Prime, Tudor, Lion One, Thor, Lumina, Mako, Amex, Minera Alamos, Chesapeake and Eskay, which offer a decent split across production, development and exploration (Figure 4). This leaves out the largest cap TSXV gold stocks, Artemis, New Found Gold, G Mining and Osisko Development, which were listed in between late 2018 and 2020, as we wanted to include the end of the last gold bear market.
While net asset value is the ideal valuation method for miners, its calculation is laborious, and especially for early-stage juniors, there is often not much concrete data on which to base the valuation. Also, to track changes over time would require calculating NAVs for multiple companies over several years, and NAV can also vary widely across source depending on the assumptions used. With most of the TSXV gold and silver juniors not generating earnings, price to cash flow or price to earnings multiples are not options. The remaining metric is price to book, or market cap over the value of equity, easily sourced from market statistics and financial statements.
While market cap is clear, comprising the price times the number of shares, the composition of the book, or equity, of a junior miner is less so. In accounting terms, the book is equity, or assets minus debt and other liabilities. However, as most juniors have no, or low, debt, with the exception of producers, what remains is assets, mostly cash and capitalized exploration expenditure, which is based on cash previously spent on exploration. So what the price to book really shows is the market’s confidence in the company’s ability to take the cash currently held or already spent on exploration, and turn that into future cash flows.
The aggregate price to book of the twelve TSXV juniors certainly shows the market’s confidence in the sector surging in 2020 and 2021. The group’s market cap in 2017 was just CAD$894mn versus a CAD$432mn in equity for a relatively low 2.1x price to book, which declined further to 1.9x in 2018 (Figure 6). However, as gold started to rise, and the market started to price in greater potential for these companies to eventually generate strong cash flows, the P/B picked up to 3.7x in 2019. The real boom for the sector was from 2020, with the market cap surging to CAD$3,566 in 2020 on an equity of CAD$643mn, for a peak price to book of 5.5x. The high confidence continued in 2021, but the price to book declined to 4.4x, as the market cap edged down to CAD$3,420mn and equity rose to CAD$784mn. The market has become more cautious over the last two years as gold has repeatedly reverted to its four-year average, bringing down the multiple to 2.5x in 2022 and just 2.0x in 2023.
Figures 6 and 7 show the composition of the aggregate equity and market cap
between the companies, highlighting their different policies on capitalized exploration
expenses. Some companies do not capitalize their exploration costs, but rather
expense them directly, and therefore do not build up this large asset on their balance
sheets. For these companies their main asset is current cash and their equity tends
to be lower than those that capitalize exploration expenditure.
The large proportion of the equity aggregate for Lion One, Chesapeake and Tudor can be attributed to high rates of capitalization of exploration, while the low figure of Reunion, Lumina and Eskay is because they either do not capitalize exploration at all, or at a low rate. There remains a debate as to whether exploration expenses should be capitalized, as if they do not eventually lead to a cash generating mine, they need to be written off, and can lead to a sudden decline in the book value of a company. Producers like Thor and Robex have a relatively high equity as they have established mines which are accounted for as large assets on the balance sheet.
In Figure 8 we show the individual price to ratios for the twelve stocks included in the average. For companies that do not have exploration assets, or have had periods of low cash, the price to book can reach very high levels in some years, including Eskay, Lumina, Minera Alamos, Reunion, or Mako. Eskay also had one year with a heavily negative P/B as its equity went negative. The rest of the group has seen their price to book only reach maximums around 8.0-11.0x times, including Tudor, Amex and Prime, while Chesapeake, Lion One, Thor and Robex had much lower peak P/Bs between 1.7x-3.1x. Companies already in regular commercial production like Thor and Robex tend to have lower price to books as their equity is rising as they are generating cash, and major surprise share price moves are less likely than for exploration companies which can have unexpectedly strong drill results.
For the larger TSXV silver companies, there are just five in the group used for the aggregate P/B, with all listed since at least 2018, slightly later than the 2017 used for gold. These include Vizsla, Dolly Varden, Abrasilver, Guanajuato and Silver Tiger, with the other large cap stock Andean excluded, being only listed in 2019 (Figure 9). There is a similar trend in the price to book ratio to the gold stocks, starting at a low 1.8x in 2018, edging up 2019 to 2.0x, and peaking in 2020 at 4.7x (Figure 10). The market cap peaked in 2021, at CAD$1,009mn, for a twenty-fold rise versus 2018, although the P/B declined to 3.6x as the equity increased to CAD$282mn. The price to book pulled back further in 2022, to 2.1x, and this year has reached 1.7x, back near 2018 levels. Silver equity rose over the whole period from 2018 to 2023, up sixteen times to CAD$462mn compared to CAD$29mn in 2018. This shows a much larger percentage rise in equity investment in these silver stocks than for the gold group, with equity rising just below three times from 2018 to 2023.
In terms of the equity split for the group, only Vizsla stands out for a very high contribution to the total equity, at 52% in 2023, up from just 6% in 2018 (Figure 11), and it also has a relatively high contribution to the total market cap at 36% (Figure 12). In 2018 Silver Tiger had the largest contribution to equity, and Dolly Varden was the largest proportion of the market cap, but both of these had declined significantly by 2023. The price to books for the silver group have been less volatile than for gold, and all had peak multiples in a much tighter range between 3.0x to 6.3x (Figure 13).
With valuations for TSXV gold and silver back down to 2017 and 2018 ‘bear market’
levels, it does shows that they are historically low. The question now becomes
whether there is enough risk in the system to push already low valuations even lower.
We consider two scenarios; one bearish, which could drive down valuations further,
and one bullish, which could see valuations rise, to illustrate the outlook for 2024.
These are likely exaggerated too much to the down and upside, respectively, with the
actual outcome probably landing somewhere between the two.
In a bearish scenario, the Fed maintains rates at current levels, or even raises them, and yet inflation remains above target, while economic growth slows, a stagflationary scenario. At the same time, geopolitical risk could flatten at its current high level, not rising enough to drive up gold or silver that much. In this situation equity markets get hit hard by the combination of high rates and low growth, with a continued risk off move hitting small caps, including juniors, as there is no offsetting lift from the gold or silver price, and juniors struggle to raise capital in a high interest rate environment.
In a bullish scenario, falling inflation and slowing growth allow the Fed to ease monetary policy considerably, at the same time as geopolitical risk spikes further, seeing gold and silver surge. While the slowing growth could hit equity markets at first, this could be offset by the return to easier money, with any slide in small caps overall, including junior gold and silver, offset by a rise in their underlying metal prices on a flight to safety, with a boost from lower real yields and a rising money supply.
All the gold producers and most of the large TSXV gold stocks slumped on the drop in gold offset and small cap equities (Figures 14, 15). For the TSXV gold companies operating domestically, Artemis Gold and Osisko Development reported Q3/23 results, New Found Gold closed its CAD$56mn bought deal financing and Snowline released drill results from the Rogue Project (Figure 16). For the TSXV gold companies operating internationally, Prime Mining reported drill results from the Tahonitas, or Z-T Area, of the Los Reyes project (Figure 17).
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.