Resource Insight – May 2023
Metal prices and mining stocks under pressure as China’s data disappoints
Our thesis on the resource sector, particularly the junior mining sector, has not changed materially. While we do recognize that markets have been somewhat volatile so far in 2023, we see more stability going forward as the main instigator of volatility (inflation) abates. Reviewing the year so far, all the gains that were lost mid-March in the S&P/TSX Composite Index (from escalating fears related to contagion in the global banking sector) were gained back again in April and May, resulting in the index up approximately 4.4% year-to-date at the time of writing. And the TSX Venture Index, composed mainly of small cap mining companies, is now up some 6.4% year-to-date, which is impressive given that it had lagged the overall market.
Price Returns – S&P TSX / S&P Venture (year-to-date)
But this doesn’t necessarily imply strength in the Metals and Mining sector. Base metal equities have been under pressure recently on continued demand weakness in China and a stronger US dollar, a trend that is exacerbated in the junior mining space. The sell-off in metal prices throughout the months of April and May has been a fallout from China CPI reaching the lowest level in two years at 0.1% year-over-year(vs. consensus of 0.4%). Also impacting the price of metals was China’s industrial production for April that was well below consensus and thus more monetary easing may be necessary in the coming months to support China’s economic recovery and achieve their 5% GDP target. Lastly, on May 16, 2023, global markets and commodity prices were not impressed by China retail sales that fell by 7.8% month-over-month, which makes April the second worst month of April so far this century. This also brings the case for stimulus in China to the forefront.
Positive developments that lie ahead
On a positive note, North American copper equities are now pricing in $3.33/lb copper vs. the current copper price of $3.74/lb, implying an approximate 12% discount. This mispricing would be even more magnified in the junior mining sector, suggesting that junior mining stocks have a lot of room to run to catch up to fair value.
North American Copper Equities Pricing in $3.33/lb Cu.
Source: RBC Capital Markets
And, as we have pointed out in previous editions of Resource Insight, the mining sector remains undervalued. As can be seen in the chart below, enterprise value per turn of EBITDA (EV/EBITDA) for base metal producers has recently climbed, however with our expectation of much higher copper (and commodity) prices this year, we believe that the dislocation seen below between valuations and commodity prices will remain, supporting further upside in the mining sector.
Long-Term EV/EBITDA Time Series
And while global growth has slowed significantly, global inventory levels for most metals remains extremely tight as we approach mid-year, which should continue to provide strong support for metal prices. In previous editions of Resource Insight, we have discussed the challenges in the mining sector that is leading to short supply and today, these factors remain very much in place. Regardless of which commodity you consider, global inventory levels are extremely low as can been seen for copper and nickel in the charts below.
Copper Weekly Inventory & LME Prices
Nickel Weekly Inventory & LME Prices
Here, our thesis on global demand for commodities remains essentially the same. With global inflation abating, growth should return to a more normalized path. Combined with short supply, commodity prices should gain substantially in the coming years. Updating our demand chart, we once again use copper as a proxy for commodity demand, which should grow for the next several years and especially for China.
Long-Term Global Copper Demand in Tonnes and Growth Percentage (160-2027E)
Thus, we believe that with a short supply of most commodities and a strong global demand picture for the commodity sector, longer-term we are entering another high-growth commodity cycle.
The inflation outlook has more of an impact on the junior mining space than one may expect. The Canadian, US, and global economies can not grow in an inflationary environment where central banks are raising interest rates and inflation levels remain high. The latest U.S. Consumer Price Index (CPI) data released on April 12 (March 2023 CPI data) showed that inflation declined to 5.0% in March from 6.0% in February and 6.4% in January. Most economist are calling for inflation to decline further in 2023 and we should exit the year with the U.S. CPI Index at approximately 4.4% year-overyear. This also bodes well for equity markets and specifically for the junior mining sector.
In summary, inflation continues to be along the right trajectory – lower, which means that central banks around the globe can begin to calm their aggressive interest rate policies. And with the supply/demand picture and valuations both remaining supportive, we believe we should see gains in the commodity space 2023, particularly in the junior mining sector.
Glenn Drodge, Senior Portfolio Manager