by Imaru Casanova – Deputy Portfolio Manager
Gold hit a yearly high of US$1,960 on February 2, only to drop almost US$100 per ounce from that level the next day following a stronger than expected January jobs report in the US.1The rest of the month was dominated by the same narrative: a resilient economy, as further demonstrated by a sharp rebound in US retail sales2and inflation above estimates3will keep the US Federal Reserve (Fed) committed to hiking interest rates—which is viewed as positive for the US dollar and negative for gold. The US Dollar Index (DXY) was up 2.7% in February, while gold was down 5.3%, closing at US$1,827 per ounce on February 28.
While gold equities were up almost twice as much as gold in January, they were down around twice as much in February. The NYSE Arca Gold Miners Index was down 10.44%.
Gold moves, misguidance rattle the miners
The performance of gold stocks is a result of their strong leverage to the gold price, but in February it reflected underperformance due to reported results and 2023 guidance that were below expectations. Operating and capital cost guidance for 2023 was the biggest disappointment, with companies still feeling the impact of inflation on their operations and projects, and also perhaps due to more conservatism built into their estimates.
Gold miners also struggled to maintain and/or increase annual production. Agnico-Eagle, one of the largest and highest quality companies in the gold sector, has a solid track record of meeting and often beating expectations. In February, the company provided three-year guidance that shows annual production growing 7% by 2025 relative to 2022, but below consensus estimates and at higher costs. Although Agnico’s stock fell following the update, it has bounced back since. The company’s strong management team gives us confidence that it can navigate the recent operational challenges. It’s low risk, low capital expenditure, and organic project pipeline should support further growth.
“Value creation” over “growth”
For Newmont, the world’s largest gold miner with 6 million ounces of gold produced in 2022, growing or even sustaining production is a formidable task. The company more than replaced all the ounces it mined in 2022, growing reserves from 92.8 million ounces at the end of 2021 to 96.1 million ounces of gold at the end of 2022. Finding or converting 9.3 million ounces of reserves in one year is no easy task, and for Newmont it translates to only 6 months of additional production (net of depletion). This highlights the challenges Newmont and the gold industry face in delivering growth.
Our definition of growth, includes not only annual production growth, but also operating margin and reserve growth. For example, a company produces 1 million ounces of gold today, and it is projected to produce 1 million ounces of gold next year, many would consider this company to have zero growth. But if next year’s ounces are produced at a lower operating or capital cost, then cash flow will grow, which is considered growth. If the company produces the same number of ounces the following year, but through exploration or acquisitions it manages to sustain this production level by additional years, its net asset value will grow, and this is also growth. We view growth as anything that grows the value of the company over our estimated operating horizon. Thus, “value creation” rather than “growth” is a better term to define the success of a company’s strategy.
Sector consolidation trend: M&A picking up across the market cap spectrum
We are seeing M&A activity pick up across the seniors/majors, mid-tiers and juniors space, and this is encouraging.
For example, Newmont has offered to acquire Newcrest, the largest Australian gold producer. While Newcrest has rejected Newmont’s offer, the company is willing to work with Newmont to allow them to advance their due diligence process. Within the juniors space, Integra Resources and Millennial Precious Metals entered into an agreement to combine the companies under a no premium, merger of equals transaction.
Notably, the gold mining industry is fragmented, to its own detriment. We think that companies need to do more to attract investors to the sector. They must raise their profile and one way to do so, in our view, is through consolidation.
- Newmont’s management seems to agree with us on this. We met with them at the BMO Capital Markets Global Metals & Mining Conference in Florida last week, and they emphasised that the impetus behind its offer to acquire Newcrest, the largest Australian gold producer, is unquestionably value creation. They referred to it as “Value over Volume”, to signify that the transaction would seek to grow the value of the combined entities not just the number of ounces Newmont produces. Newcrest has rejected Newmont’s offer but is willing to work with Newmont to allow them to advance their due diligence process. Newmont seems committed to exploring the combination, yet not desperate. While in early stages, we expect Newmont to conduct a responsible evaluation that firmly adheres to its promise of value accretion.
- Mid-tier miner B2Gold also sees an opportunity to deliver value creation to the gold industry. On February 13, the company announced an agreement to acquire junior developer Sabina Gold & Silver in an all-share transaction.1Sabina owns the Goose asset, a fully permitted, construction ready project in Nunavut, Canada, with mineral reserves of 3.6 million ounces of gold. A feasibility study highlights production of around 200,000 ounces of gold (about 20% of B2Gold’s 1 million ounces in 2022) over a 15-year life, at all-in sustaining costs (AISC) of $775 per ounce (compared to B2Gold’s AISC of $1,033 per ounce in 2022). We view this combination positively. We expect that B2Gold’s proven ability as experienced and successful mine builders and operators should lead to improved returns and significantly reduce construction and start up risks at Goose. The addition of Canada to B2Gold’s asset base should also benefit its market valuation multiples.
Markets overlooking the impact of higher-for-longer rates
The gold market is pricing in an environment of higher interest rates due to better-than-expected US economic activity and slower-than-expected disinflation. The probability of a June rate hike by the Fed increased from about 4% at the beginning of February to more than 70% at the end of the month. Gold has managed to stay above US$1,800 per ounce, relatively unchanged year-to-date, as of end of February, despite expectations for a more aggressive Fed policy trajectory. The gold price is demonstrating resilience, even when holdings in global gold bullion ETFs, the best proxy for investment demand, continue to decline.
We believe the market is ignoring the negative effect of sustained higher rates on the global financial system. Interest expense will become a significant problem as record levels of debt across the globe are impacted by higher rates. This increasing debt burden, combined with a slow economy and sticky, elevated inflation, make for an uncertain outlook, in our view. This should be supportive of gold prices in 2023 and longer term.
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