Is Inflation Peaking?

Gold down as inflation eases

Gold dropped -3.5% this week to US$1,642/oz, as US inflation declined for the third month, which along with rising US nominal bond yields is making real yields less negative and holding bonds versus yield-less gold more attractive than in early 2022.

Valuations for larger TSXV silver companies have pulled back

This week we take a look at the larger TSXV silver companies, with the group’s overall operational performance over 2022 generally strong, but their share prices and valuations mostly down on pressure from falling silver prices and equity markets.

Producers and juniors plunge on gold and equity slide

The producing and junior gold miners were down heavily, with the GDX losing -6.8% the GDXJ dropping -7.8% and the large cap TSXV gold stocks mostly declined as gold fell to its lowest level since March 2021 and the equity markets declined.

Is Inflation Peaking?

Gold was down -3.5% to US$1,642/oz, as US CPI inflation declined for the third consecutive month to 7.86% yoy in September 2022 (Figure 4). The falling inflation and rising nominal US bond yields have meant that real US bond yields are getting far less negative, rising off of lows of -6.4% in March 2022 to just -4.4% as of September 2022. While still not very attractive as an investment in absolute terms, these bonds are becoming relatively less unattractive than alternatives like yield-less gold, and fund flows could therefore relatively be favoring bonds over gold for now.

With US inflation now down over 2.0% from its highs, it does raise the question of whether US inflation is peaking, at least in the US, with the US Federal Reserve's aggressive rate hikes seeming to be showing some progress on curbing inflation. In contrast, inflation in Europe and Japan has continued up, with CPI inflation in Europe at 9.14% as of August 2022, surpassing the US peak, and at 3.01% in Japan, which is high for an economy that spent much of the past three decades mired in deflation.

US ahead of the curve on rates hikes versus Europe and Japan

This is partly because the US has been ahead of the curve versus the rest of the world in its rate hikes. Historically in periods of high inflation, interest rates have needed to reach or exceed the inflation rate itself before price hikes are truly curbed. We see in the Figure 5 that US 10-year bond yields have reached 4.0%, which puts them at about a half of current inflation. However, the largest two European economies, Germany and France, have 10-year yields at just 2.3% and 2.9%, leaving them still well behind the over 9.0% inflation they face. While yields in Italy have spiked to 4.8%, it has a smaller weighting, and while UK rates are over 4.3%, this has only happened in just the last month after a shock tax cut by the new government. Rates in Japan at just 0.2%, the biggest gap in percentage terms to catch up with their inflation.

So while US inflation may have peaked, it seems that global inflation may still have some room to run. If we add to this the strength of the US$, it seems likely that gold priced in US$ terms could continue to see pressure for the rest of 2022. However, gold priced in currencies other than the US$ has performed reasonably well this year, and if global rate hikes continue to lag global inflation, gold's performance in terms of other currencies could fare considerably better.

Shifting focus from inflation to unemployment

Even if inflation has peaked in the US, it is still high in absolute terms, and the US Fed has showed no signs of backing off its commitment to crush inflation, and neither a recession in the US or crashing equity markets have seen it show any real signs of a pullback. At most it has indicated that it could pause interest rate hikes, but would maintain them at relatively high levels for an extended period to ensure that inflation was curbed, and seems to accept that this could drive a major recession. At what point could a downturn become so harsh that the Fed would be forced to pullback?

The answer to this lies in the Fed's dual mandate, which is not only to maintain price stability, but to also keep unemployment levels low. The Fed is actually under no pressure from the unemployment side currently, with a rate at just 3.5% extremely low in historical terms (Figure 6). However, with the economy likely to continue to worsen with continued rate hikes, we could see unemployment start to rise again, which could force the Fed to at least pause its rate hikes. So while we already know how the Fed will react to high inflation and low unemployment, it is still unclear how it will react to high inflation in the context of high unemployment.

Could silver rise or gold fall to bring their ratio near recent average?

This week we look at the performance and valuation of the larger TSXV silver stocks, which, like most of the junior miners, small cap equity and broader equity markets in general, have been under pressure this year. With the Fed likely to continue to keep rates high, this downtrend looks more likely to continue than not through the rest of 2022 and into early 2023, although it could potentially be driving many of these companies into bargain territory later in 2023. While the larger TSXV silver stocks are generally seeing decent operational progress this year, they have been hit by the 21.0% decline in the silver price year to date.

In determining whether the downtrend will continue to for silver, one key indicator is the gold to silver ratio, which has risen to 91.2 currently, moderately above its 81.9x average since 2020 (Figure 7). While this could indicate that silver could gain to bring the ratio down closer to its average, it could also mean that gold could decline while silver holds flat. Given the current pressure on gold from increasingly less negative real yields and the strong dollar, this latter outcome may be more likely. With the longterm average for the gold to silver ratio at just 52.6, a reversion to this level could indicate a major relative surge in silver relative to gold, but this seems unlikely as a short-term trend for 2022 and more likely to occur over several years.

Silver price likely hit by concerns of weakening industrial demand

The silver price has been hit in the broader correction in most major industrial metals that started from around March 2022 to May 2022 as concerns on the outlook for global economic growth started to increase as global interest rates started to rise. Silver's decline this year is much closer to other industrially-driven metals like copper, which is down -22.3% YTD, while other precious metals like gold and platinum are down just -8.7% and -6.6%, respectively.

This is because while silver is driven by monetary factors to a degree, it has a much higher proportion of demand from industrial sources, at 55% of the total, than gold, at just 8.0% (Figure 8). Gold is far more driven by monetary factors, with 25% of demand from investment, 11% from central banks and 55% from jewellery purchases which to a large degree are driven by gold as store of monetary value. While the proportion of investment demand for silver is slightly higher than gold, central banks no longer hold silver and its jewellery demand is much lower. We expect therefore that further signs of high-interest-rate-driven weakness in the economy could continue to drive down silver.

Large TSXV silver companies continue to progress under macro pressure

Even with a weakening macro backdrop, the large TSXV silver companies continue to show operational progress, with the group operating mainly in Mexico and South America. Discovery Silver and Vizsla Silver are exploring in Mexico, with projects at the PEA and Resource Estimate stages, respectively (Figure 9). Eloro Resources is drilling, and Santacruz Silver Mining and Andean Precious Metals both producing, in Bolivia, and Abrasilver has a PEA-stage project crossing the Argentina-Chile border. The only company in the group outside of this region is Dolly Varden, at the Resource Estimate stage in British Columbia, Canada.

While Discovery continued to drill at its Cordero project to support its Pre-Feasibility Study this year, after releasing a PEA in November 2021, and released results from a metallurgical test project in August 2022, this has not boosted the stock price, which is down -47% this year (Figure 10). Vizsla reported metallurgical test results for Panuco in March 2022, restated its maiden Resource Estimate for the project in March and and has reported strong drill results for the project through 2022, but is also down substantially, by 44% YTD. Eloro has reported strong drill results for Iska Iska throughout 2022, offering support for its share price, down just -9% this year.

Abrasilver's release of its PEA for Diablillos in January 2022 and continued reporting of strong drill results year to date has led to a 7% gain in its share price YTD. Santa Cruz operates two producing mines, Veta Grande and Rosario and the exploration projects Minillas and Zacatecas, and has seen an improvement in its mining operations over the year, driving by far the highest gain of the group, up 47%. In contrast, Andean Precious Metals has seen some pressure on its operations this year, with its San Bartolome mine generating a net loss over H1/22 on the drop in silver prices, and had the largest share price decline, down -54%. Dolly Varden has continued resource expansion, upgrade and exploration drilling this year, with its share price down -22%.

Valuations generally trending down for large TSXV silver companies

The valuations overall have been trending down for the large TSXV silver companies this year. On a market cap/resource basis, the shift in valuations has been split, with Andean, Vizsla and Discovery seeing considerable declines, but the multiple for Dolly Varden rising considerably, and just edging up for Abrasilver and Santa Cruz, while Eloro does not have a Resource Estimate yet (Figure 11). However, weighted by market cap, the average market cap/resource for the group would be down considerably, with the big gainers having relatively small market caps.

Looking at price to book, the multiples have come down considerably for entire group except for Abrasilver, which had a moderate rise (Figure 12). This has been mainly driven by a decline in the price for these stocks, with the book value for most of the group not shifting dramatically, with the equity for Discovery, Vizsla and Abrasilver relatively flat and Eloro seeing moderate gains. The big gains in equity were from Santa Cruz, rising off a very low base as of end-2021 as it generated cash from production and for Dolly Varden, after a substantial capital increase.

Target price downgrades, but strong upside to consensus

Target prices for the group also have been trending down this year, with significant upgrades only for Dolly Varden, with Discovery, Abrasilver, Eloro and Andean all seeing declines, probably especially from silver price estimates being lowered in the forecasts. However, even with the downgrades, the market is still expecting considerable upside for all of the companies based on their estimated long-term value, excluding Santacruz, for which there is no consensus target. Nonetheless, given the current market conditions, while the long-term outlook for these companies may remain strong, we don't expect that they will be rapidly heading up towards these targets for 2022 and into early 2023 given continued pressure on equity markets.

Producing gold miners see substantial declines on gold drop

The producing gold miners nearly all saw substantial declines on the drop in gold and sliding equity markets (Figure 14). Barrick and Eldorado reported Q3/22 production, with Barrick seeing gold output down -9.5% yoy and copper production up 23%, while El Dorado's gold output was down -5.3% yoy. Centerra announced that the TSX had accepted its Normal Course Issuer Bid to purchase up to 15.6 mn shares, or 7.1% of its total shares and 10% of its public float (Figure 16).

Large TSXV gold juniors mostly up as gold gains

Most of the larger TSXV gold juniors were down as both gold and markets declined (Figure 15). For the Canadian juniors operating mainly domestically, New Found Gold announced that Mr. Raymond Threkeld has joined its Board as an independent director, Artemis Gold completed its CAD$175mn equity financing and Laurion Mineral Exploration provided an operational update (Figure 17). For the Canadian juniors operating mainly internationally, Arizona Metals reported drill results from the Kay Mine project, Prime Mining from the Z-T Zone of Los Reyes and Mako Mining from southwest of the San Albino West mine. Novo Resources reported Q3/22 results with production for Beaton's Creek ahead of wind-down guidance with Phase 1 near complete and Q4/22 to see an operational pause (Figure 18).