Resource Insight – October 2023
Resource Sector This Year
Unmistakably, the year 2023 has been an abysmal year for the junior mining sector. While a formal index for the sector does not exist, our own internal benchmarks suggest that this sector may be down approximately 40% year-to-date. Deteriorating commodity prices, global macroeconomic concerns from significantly higher interest rates, an anemic recovery in post-lockdown Chinese demand, a stronger U.S. dollar, and elevated geopolitical risks (Russia/Ukraine and now Israel/Palestine) have all weighed heavily on the sector.
However, several strong themes have emerged in specific key commodities that should provide somewhat of a floor to the sector. While gold prices have also been under pressure by rising real rate projections as restrictive monetary policies appear to be extended, support for gold (and even higher gold prices) remains very much part of our forward view for this commodity. Slowing growth and inflation for the remainder of this year and into next year should provide a backdrop for current central bank policy headwinds to decline, which should strongly correlate with higher gold prices.
And then there is the uranium sector. This sector has been characterized by ongoing tightness in the uranium market, with demand far outstripping supply. Due to the ongoing forecasts for deficits in this market, uranium fundamentals continue to improve based on the Western world’s agenda for both decarbonization and energy independence. This has resulted in a markedly improved pricing environment and the outlook for nuclear power, and by extension uranium, has not looked this positive since before the Fukushima disaster in 2011.
And we remain bullish on copper. Given the extreme challenge building new large-scale copper capacity, we continue to see a heightened M&A environment, supporting the potential for many junior copper miners to be acquired. While the copper market is currently in balance, large structural deficits will occur as the demand for copper grows exponentially from both the electrification of the energy sector and the demand originating from the manufacturing of electric vehicle batteries. With global inventories already sitting at critically low levels, the price of copper will be higher in the coming years.
As can be seen in the chart below, the S&P/TSX Venture Index, which is composed mainly of small capitalization mining companies, is down over 10% year-to-date and has lagged the overall Canadian equity market.
Price Returns – S&P TSX / S&P Venture (year-to-date)
Source: Bloomberg
And the junior mining space has considerably underperformed the S&P Venture index, which means that this has been a disappointing year for investors in this space. But on a positive note, our thesis on the resource and junior mining sectors remains intact and further stability in these sectors will materialize as the main instigator of volatility (inflation) abates.
Resource Sector Remains Undervalued
Valuations
North American copper equities remain at a discount. As seen in the chart below, North American copper-producing equities are now pricing in an approximate $3.30l/lb copper price vs. the current copper price of $3.58/lb, implying an approximate 8% discount. This ongoing mispricing would be considerably 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 $3.30/lb Cu.
Source: RBC Capital Markets
In addition to commodity pricing valuations, the sector remains relatively cheap on a fundamental basis as well. An updated chart highlights enterprise value per turn of EBITDA (EV/EBITDA) for base metal producers is shown below. With our expectation of much higher copper (and commodity) prices into next year, we believe that the dislocation seen below between valuations and commodity prices will widen, supporting further upside in the mining space.
Long-Term EV/EBITDA Time Series
Source: Scotiabank
Supply/Demand
The backdrop here remains very attractive as global inventory levels for most metals remain extremely tight, which should continue to provide support for metal prices on a longer-term basis. If that is considered in combination with demand that should increase as inflation abates and global growth is restored along a more positive trajectory, the demand for commodities and companies that explore for, and produce, such commodities should find market pricings that are much more true to their actual value.
New Commodities Supercycle?
What has been gaining attention in the commodities space recently is the relative outperformance of commodities versus equities since July 1. As can be seen in the chart below, since mid-year, commodities are beginning to outperform relative to stocks, as represented by the S&P/TSX Composite Index. Many investors are now wondering if this is the beginning of the second leg of a super commodity cycle that would have begun in April 2020. In our view, it remains to be seen if this is the case, however, conditions are beginning to come into place.
Bloomberg Commodity Index vs. S&P/TSX Index
Source: Bloomberg
Thus while the commodity space has been soft since the peak on June 16, 2022, the weakness looks to have stabilized and the sector is trending positive once again.
Summary
While we did not discuss inflation in this edition of Resource Insight, it does continue to stabilize in both Canada and the United States. The implications for this are central banks can begin to slow their aggressive interest rate policies, which bodes very well for both equities and commodities space. Combining this with a commodities market that is trending well again versus equities, the supply/demand backdrop that remains highly supportive for the Metals & Mining sector, and valuations that remain supportive, we believe we should see gains in the commodity space in 2024, particularly in the junior mining sector.