Inflation-Induced Speed Wobble

Gold dips briefly below key level on inflation surprise

Gold declined -0.6% to US$2,012/oz this week and dipped below US$2,000/oz for two days after forty-one days straight above this benchmark, as both US CPI inflation and the US PPI came in hotter than expected, lowering rate cut expectations.

Big Mining trading at major discount to Big Tech

This week we compare the market cap and valuations of the largest global mining companies versus US big tech, which shows the most major divergence in twenty years and points to a significant relative undervaluation of the large mining companies.

Gold stocks drop as metal and equity markets slide

The producing gold stocks were down on the decline in the metal and large cap equity, with the GDX losing -3.7%, and junior gold declined even with the broader gain in small caps, with the GDXJ dropping -3.5%, while TSXV large gold was mixed.

Inflation-Induced Speed Wobble

The gold futures price dipped -0.6% this week to US$2,012/oz and closed below the key US$2,000/level for two days after a forty-one day stretch above this benchmark, its longest ever. The dip was driven especially by US CPI data but also a US PPI print that both came in hotter than expected. This raised concerns that the Fed could hold off on rate cuts longer and expectations for a March 2024 cut dropped to just 10%. However, markets recovered somewhat after Fed officials followed up with comments that the markets should not overweight a single month of inflation data.

US equity markets lost momentum, with a plunge in several of the megacap tech names driving much of the gains over the past year. Microsoft dropped -4.0%, Apple -3.3%, Amazon -3.3% and Alphabet -1.5%, leading to a -0.5% decline in the Nasdaq, its second largest weekly drop since November 2023 (Figure 4). While a heavy tech weighting also pulled down the S&P 500 -0.42%, US small caps gained, with the Russell 2000 up 0.9%. The larger cap equity weakness and gold decline pulled down producing gold stocks, with the GDX producer ETF off -3.7%, and the small cap rebound was not enough to support junior gold, with the GDXJ declining -3.5%.

US CPI inflation and PPI come in hotter than expected

The key data point that caused the speed wobble for both the gold price and equity markets was January 2024 US CPI inflation. While the headline figure declined to 3.0%, from 3.3% in December 2023, this was still considerably above expectations (Figure 5). Headline US inflation has become more stubborn over the past seven months, averaging 3.3%, after huge gains in the inflation fight from mid-2022 to mid2023, with a decline from nearly 9.0% to around just 3.0%. This continued lack of progress for over half a year now has concerned markets hoping that further inflation declines would increase the likelihood of the Fed starting to cut rates.

Core inflation was also an issue, as it can be weighted more heavily in Fed rate decisions than the headline figure, and was flat month on month at 3.9%, still almost twice the Fed’s 2.0% target. There was also a negative surprise in the US Producer Price Index (PPI), which measures inflation further up the supply chain, with a 0.4% month on month rise in January 2024, its highest in fourth months, after three months of contraction (Figure 6). The inflation measure the Fed weights most heavily is the Personal Consumption Price Index, with the January 2024 figure to be reported at end of February. This is likely to be particularly scrutinized given that the hot CPI and PPI data are implying that Fed may need to keep rates higher for longer.

Big Mining to Big Tech market cap ratio at over twenty-year lows

We have highlighted the rising disparity between US megacap tech versus many other US sectors and other global markets, including global mining, for the past several weeks. Given the first real signs in many months that the US big tech boom might be slowing, this week we look at the market cap and valuations of the largest global mining stocks versus the largest US tech stocks, highlighting the cavernous gap that has developed between the two sectors.

The ratio of the aggregate market cap of the top four global mining companies, BHP, Rio Tinto, Vale and Southern Copper, or Big Mining, versus the top four US tech companies, Microsoft, Apple, Amazon, and Nvidia, or Big Tech, is shown in Figure 7. While this metric currently stands at just 4.1%, the small relative size currently of Big Mining versus Big Tech is a major anomaly over the past two decades. The measure peaked at 106.2% in 2009, with Big Mining at the time actually the larger of the two, as large tech companies plunged on the global financial crisis at the same time many metals prices were starting to pick up.

The DJ All Metals Index shows metals pricing booming by 2010, which kept the Big Mining to Big Tech market cap ratio above 100%, and while the metals peaked at 213 in July 2011 they had started to decline by the end of that year, and the ratio had declined just 58% (Figure 8). The All Metals Index slumped over the next four years, reaching a low of 113 in November 2015, and while it picked up over 2016 and 2017, it averaged just 160 from mid-2017 to mid-2020 and the Big Mining to Big Tech ratio averaged just 12% from 2015 to 2019.

However, there has been a major rebound in the All Metals Index since 2020, rising to a peak in March 2022 at 264, and while it has pulled back to 215 as of February 2024, this is still just above the July 2011 level. Interestingly, this rise in metals prices has not driven up Big Tech much, and it has been dramatically outpaced by gains in Big Tech, with the ratio between the two sectors averaging just 6.0% from 2020 to 2024, the lowest in a couple of decades.

Big Mining and Big Tech at similar size fifteen years ago

Looking at the specific companies behind these aggregates in five-year intervals, in 2004, the Big Tech market cap was almost entirely Microsoft, and mining was roughly evenly split between BHP, Rio Tinto and Vale (Figure 9). By 2009, mining and tech were roughly similar sizes, at US$562bn and US$530bn, with mining companies up on rising metals prices, and Apple a larger proportion of tech. By 2014, mining had been nearly cut in half to US$258bn on the metals price slump, while tech more than doubled to US$1,180bn, from a huge jump in Apple and strong rise in Amazon.

By 2019, after a seven-year metals price bear market, the mining market cap had risen to only US$337bn, while tech tripled to US$3,551bn, requiring a change in axis for Figure 9, with the aggregate relatively evenly split between Microsoft, Apple and Amazon. As of 2024, even though metals prices have now soared, the aggregate market cap of the mining companies has held near flat at US$338bn, while the tech market cap nearly tripled again, with Microsoft, Apple and Amazon jumping in size, and Nvidia also becoming heavily weighted in the aggregate.

The severely lagging market cap of mining versus tech raises the question of how justified such a huge gap is, especially after the strong rebound in metals prices over the past few years. To answer this we look at the three drivers of share prices; earnings growth, return on equity, and multiple expansion. The first two are taken directly from accounting statements or analysts’ estimates and focus mainly on the most recent financials and one or two years of forecasts. In contrast, share price multiples like price to earnings (P/E) or price to book (P/B) reflect the market’s longterm expectations for growth rates. If they are high, it is expected that that high growth will be sustained over a long period, and vice versa.

Growth expectations for some Big Miners at or above levels of Big Tech

Starting with earnings growth in Figure 10, the forecast 2024 increase is plotted against the P/E, with the expectation that higher growth would be afforded a higher multiple. Here we see some support for short-term bearishness on the mining sector, with the forecast net income for 2024 for both Glencore and BHP expected to decline, affording both a relatively low P/E ratio. This contrasts with the decent or better growth expected for all of the tech companies and their relatively high multiples.

However, the other big miners have forecast earnings growth at, or even above, big tech, but their P/E multiples are much lower. Vale and Alphabet have similar forecast growth of 13% and 14%, but a big gap in P/E of 4.9x versus 20.7x. Rio Tinto has higher expected growth than all of Big Tech except for Amazon, at 27%, but a multiple of just 8.5x. Southern Copper is the only Big Miner trading at multiples near Big Tech, with a P/E of 24.5x on 9% growth. Figure 11 adds Meta and Nvidia, outliers with huge 2024 growth, and while Nvidia’s high multiple reflects this, Meta’s multiple is not high versus tech, implying the market expects the growth not to be sustained.

Market’s expectations appear high for tech and low for mining

These higher multiples for tech versus mining imply market expectations that high growth will be maintained for the former, but not the latter. However, as multiples continue to rise, higher growth must be delivered for longer, and the probability of missing estimates rises substantially. In contrast, lower multiples leave more of a margin for error, having already priced in some degree of downside outcomes. At this point, the market seems to pricing in almost perfection for US tech, but has quite a bearish view on mining, and is already pricing in a considerable slump in overall metals prices from a potential recession. We believe that this could be setting up a potential disappointment from tech and upward surprises from mining.

Undervaluation of mining versus tech implied by P/B to ROE

While the earnings growth and P/E ratios shown above can be quite volatile from year to year, the book value of a company, or its equity, and its return on equity (ROE) and price/book tend to be more stable over time and are therefore are also worth considering. Figure 12 plots the market’s 2024 forecast for ROE and price to book, with higher returns expected to correspond to a higher P/B value. Compared to the earnings growth and P/E chart, the conclusion seems clearer, with the market paying much higher P/Bs for Big Tech versus Big Mining, despite similar ROE levels.

The Vale versus Alphabet comparison shows up again, with ROEs the same at 26% but a large spread in their 1.4x and 5.1x P/Bs. BHP and Meta also have close returns, at 31% and 30%, but the former’s 3.1x P/B is half of the latter’s 6.1x. Rio Tinto and Amazon are also comparable, with ROEs of 23% and 18%, but a P/B of 2.0x versus 6.3x. Again Southern Copper stands out for high multiples closer to tech. In Figure 13 we add Apple and Nvidia, with their extreme expected 2024 returns of 153% and 91% giving more justification to their very high P/Bs of 38x and 41x, respectively.

In contrast to P/E, some of this tech versus mining P/B gap could be attributed to differing accounting between the sectors. The ‘book’ of tech companies tends to be lower, given high human capital, and less physical capital, which does not accumulate on a balance sheet as much as the hard assets mining companies purchase. However, if a wide P/B spread was because of these issues, we would expect it to be consistent over time. Comparing the two groups in 2005, 2010, 2015 and 2022 does not suggest that this is the case, with the P/Bs of the two sectors quite close for the first two periods, with mining actually higher in 2010 (Figure 14). The spread widens in 2015 clearly because of the metals price slump, and then jumps by 2022 because of a substantial rise in market expectations for Big Tech.

Gold producers and large TSXV gold mixed

The gold producers and large TSXV gold were mixed as the metal price fell, large caps declined and small caps gained (Figures 15, 16). For the TSXV gold companies operating domestically, New Found Gold announced drill results from the Iceberg East Zone of Queensway, Tudor Gold reported a review of its 2023 drill program at Treaty Creek and an at-the-market-program to sell up to $20mn in shares, and Laurion Mineral Exploration released an NI 43-101 Report on the Ishkoday project (Figure 17). For TSXV gold companies operating internationally, Amaroq announced a £30mn financing, Chesapeake released the initial metallurgical results from the Lucy project with gold recoveries up to 97% and Lion One closed its $12.1 mn placement (Figure 18).