Monday 15 November 2021

Expert updates

Gold & Mines – Stagflation in view? an ideal scenario for gold!

There has been no real trend on the gold market since summer began, as investors await more details on the Fed’s future policy direction direction. Over the past four months, gold has traded sideways within a $1700/$1835/oz. range, without managing to break out of it. It fell by 5.86% in dollars on the year to the end of October, ending at $1783.4/oz.

This clearly hasn’t been helped by investors’ unfailing  optimism, which sent many equity indices to new records. Even the CAC 40 (ex dividends) managed at last to break its all-time record, which had dated back 20 years! The coming rise in interest rates is an additional source of uncertainty.

Despite all the pitfalls, the gold market has held up rather well. After a wave of consolidation from its August 2020 peak of $2075/oz to its March 2021 low of $1676/oz, gold prices have found an apparently solid base of support.

Investors’ total lack of risk aversion has indeed driven down the barbarous relic, but other factors have come into play, as well, including real US rates, which remain in negative territory at about -1%, after setting a new record low in August at -1.20%. The debate has reached a fever pitch on whether or not inflation will last, as seen, for example, in the 10-year breakeven rate, which in late October hit a high since May 2006. Meanwhile, the many questions being raised on the strength of the recovery slowed the rise in the 10-year yield, which after an unsuccessful attempt to exceed its high of last March (1.77%), pulled back to 1.55%. This ongoing “stagflationary” environment would be an ideal scenario for gold!

On the other hand, the US dollar’s persistent strength continues to drag down the trend.

Outflows from gold-backed ETFs continue and now total 410 tonnes since the mid-October 2020 record, and 273 tonnes on the year to date. These are the heaviest outflows since 2013. This has sent total AuM to a low since May 2020.

The World Gold Council has released its quarterly report on gold supply and demand. After a stable second quarter, demand fell once again by an annualised 7% in the third quarter, to 831 tonnes. In the first nine months of the year, demand was down by 9%.

Almost all of this decline is due to the shrinking of AuM of ETFs backed by physical gold (-27t). Remember that ETF AuM had expanded strongly in the third quarter 2020 (+274t).

Regarding investment, keep in mind that this strong contraction in demand for gold-backed ETFs was partly offset by a 18% rebound in purchases of ingots and coins in the third quarter (262t) vs. the third quarter of 2020. Purchases of ingots and coins in the first nine months of 2021 are close to their levels of the last two full years (2019 and 2020).

Jewellery demand, meanwhile, surged by 33% (to 443t), driven by the general economic recovery but has not yet returned to its levels of previous years. As a result, demand in the third quarter is still 6% below its level of the third quarter of 2019 and 12% below its average of the past five years. The two main buyers are  China and India. Chinese demand rose by 7% from the second to the third quarter and by an annualised 32%, while Indian demand was up by almost 60%, both sequentially and in annualised terms.

On the central bank front, demand contracted sharply in the third quarter (69t: -64%) compared to the second quarter, but is in sharp contrast with third quarter 2020 demand, which was negative (-10.6t). Central banks have purchased a total of 393 tonnes on the year to date.

Supply, meanwhile, shrank by 3% (to 1238.9t) in the third quarter vs. the third quarter of 2020 (1279.4t), but this was due solely to recycling, which is highly sensitive to price trends, and dipped by 22% to 298t (vs 381.8t in Q3 2020), while mining output expanded by 4%, hitting a new quarterly record, at 959.5t (vs 919t in Q3 2020).

What about goldmines? 

In this tough market environment for gold, mines’ performance on the year to date has shown some (negative) leverage, in line with its long-term trend (2/2.5x), with a decline of -11.15% (in $) by the NYSE Arca Gold Miners NTR vs. 5.86% (in $) by gold.

And yet, goldmining’s fundamentals have seldom been so robust. After the restructuring of recent years, goldmining companies’ financial standing is extremely solid and even continues to improve, with the sector’s free cash flow now at about 6.75%.

The industry has understood this well, judging by the acceleration in M&A deals, which have been driven mainly by goldmining companies’ concerns for maintaining their gold reserves. This is seen in the merger announced between Agnico Eagle and Kirkland Lake, two top goldmining companies, to form the sector’s third-largest company in terms of output after Newmont Corp and Barrick Gold, and, above all, in the deposits located exclusively in secured regions.

In the meantime, while gold prices are 14% below the record they set last year and just 7% under their September 2011 high, goldmining shares are still 30% off their August 2021 highs and more than 50% below their September 2011 records.

The consensus nonetheless remains cautious on coming gold trends. For 2022, the average forecast price is now $1720/oz vs. $1780/oz for 2021. Against this backdrop, the goldmining industry’s 12-month prospective earnings are down by 23% vs. the same period of last year and have been lowered by 24% on the year to date. One of the main reasons for these downward revisions is the increase in production costs in recent quarters. This trend could continue in 2022, with an average forecast increase of 5%/7%.

Goldmine valuations

Far, far from reflecting current gold prices, the valuation of the goldmining sector, in P/NAV terms, is holding at close to its all-time lows! At ~0.75x NAV, valuation multiples are more than one standard-deviation below their average since July 2013 (~1.10x).

Clearly, the market is still not convinced that the goldmining industry can generate the least amount of value. And yet, all the conditions are right for it to do so.

The same goes for P/CF, which is under 6x, one standard-deviation below its 10-year average (~8.75x) even as the industry’s cash generation has accelerated considerably.

Download the full document below.

Arnaud du Plessis

Thematic Equities Portfolio Manager

Vafa Ahmadi

Head of Thematic Equities