Post on 09-Aug-2020
Research Note Gold Sector.
RESEARCH NOTE | January 10, 2019
Our disclosure statements are located at the end of this report.
All figures in US$, unless otherwise noted.
Where to Make Money in the Current Gold Sector
Event
This report builds on our Nov. 30 report, What’s Working and What’s Not in the Gold
Equity Market, outlining where there is money to be made. The upside is substantial
and the beaten-up gold sector offers a useful portfolio diversifier.
Highlights
Gold Price Has Significant Upside this Cycle I The current up-cycle began in
Dec. 2015 and has seen gold peak at only 32% above the cycle $1,051/oz low,
versus a median >100% (average >200%) for the past six cycles. Even a 50%
increase from the cycle low would take gold 23% higher than the current
$1,280/oz, yet leave this cycle weaker than five of the six up-cycles.
Gold Equities Positioned to Outperform Gold – Finally! I North American gold
equities are coiled springs, having dramatically underperformed gold since Dec.
2016. Most tiers have recovered just 11–17% of their contraction in the downturn
of 2012–2015 and are at record low valuations (P/NAV) — unlike most sectors.
Historically, gold itself is a strong competitor to the equities, however.
Current Rally Is Being Led by Big Cap, for Now I Gold equities started
matching gold’s performance in Sept.–Oct. 2018 and began outperforming in
Dec., led by the large caps. We use the rally of 2016 as a case study to show how
sharply the equities could rally if the current upturn endures even a few months
and how it could spread to the (left-for-dead) small caps within 2–3 months.
Where to Make Money in Gold Equities I All gold equities will float if a
meaningful (>10%) gold rally occurs, but many of the boats have holes.
o Developers Offer the “Best” Torque: Cardinal, Orca, Orezone, Sabina.
o Explores – the Most Torque: Cartier, Erdene, Moneta, Reunion, Revival.
o Royalty Co’s – Best Bet: Franco, Osisko Royalties, Sandstorm (Top Pick)
o Junior & Senior Producers – the Most Beaten Up, Yet the Most
Dysfunctional: Dundee Precious
o Intermediate Producers – Liquidity & Torque, But Watch for Rising
Costs : Agnico-Eagle, Semafo
Conclusion
We have been students of the gold sector long enough to know that nobody knows if
the uplift since Oct.–Nov. is another seasonal head fake, or a long-awaited resumption
of the up-cycle tide that began in Dec. 2015. If the latter is occurring, there is
substantial upside in gold (>20%), and especially gold equities (>50%), with even a
muted rally. We recommend that investors pick their boats carefully, most have flaws.
We recommend Royalty companies — best designed, best skippers. The Developers
and Explorers will likely be the fastest boats and ideally suited for a rally, despite not
being to current design tastes. The fastest-looking boats are the Producers, but the
Seniors and most Juniors have holes in them and they, along with the Intermediates —
the current favourite design — are hard to control and could well end up on the rocks
with soaring costs, like the last cycle.
Don MacLean, Sr. Analyst | 416.360.3459 | dmaclean@paradigmcap.com Don Blyth, Analyst | 416.360.3461 | dblyth@paradigmcap.com
Lauren McConnell, Analyst | 416.366.7776 | lmcconnell@paradigmcap.com
GOLD
Companies Covered
Rating Target
Agnico-Eagle
Buy C$67.00
Cartier Resources
Spec. Buy C$0.50
Dundee Precious
Buy C$5.00
Erdene Resources
Spec. Buy C$2.00
Franco-Nevada
Buy C$100.00
Orca Gold
Spec. Buy C$1.25
Orezone
Spec. Buy C$1.20
Osisko Gold Royalties
Buy C$20.25
Reunion Gold
Spec. Buy C$0.40
Revival Gold Spec. Buy C$1.85
Sabina Spec. Buy C$3.25
Sandstorm Buy C$9.50
Semafo Buy C$6.25
Paradigm Capital Inc. | IIROC/TSX member Page | 2
Research Note
Gold Sector
RESEARCH NOTE | January 10, 2019
1. Gold Price Has Significant Upside, When the Up-cycle Resumes
Analysis of Past Cycles: The current up-cycle began in Dec. 2015 and has only seen gold
price peak 32% above the cycle bottom (i.e., $1,382/oz vs $1,051/oz). The previous six up-
cycles since 1976 have had much larger increases: median >100% and average >200%.
(Figure 1).
Expect a Muted Up-Cycle, But Still Good Upside: While we doubt the current cycle has
sufficient powder to yield the power of past up-cycles, looking at Figure 1, we think the odds
are five out of six that substantially more upside exists; e.g., a 50% uplift from the $1,051/oz
trough would take gold to $1,575/oz, 23% higher than the current $1,280/oz, yet still be the
second-weakest cycle.
However, Gold Remains Fundamentally Unpredictable: Gold’s price is currently most
closely linked to the USD. The overall setting is mixed, but net positive for gold: slowing global
economy, but plenty of market anxiety and volatility; low interest rates; less upward pressure
likely on rates by central banks but still some; inflation tame but not in decline.
2. Gold Equities Positioned to Outperform Gold — Finally!
North American Gold Equities – Coiled Springs, Having Lagged Gold by Record
Proportions
o Equities Dramatically Underperformed Gold Dec. 2016 to Sept. 2018: From Dec.
2016 to Sept. 2018, the TSXG Index declined 31%, while the USD gold price increased
4% (i.e., a strong negative correlation). The turning point appears to have been Oct.–
Nov., with the TSXG slightly outperforming since Dec. 2018, but it has barely made up
any lost ground (Figure 2).
Aussie gold producers have outperformed their North American peers by 60% since
Dec. 2016. For the most part better operators, we expect the Aussies will
underperform somewhat, due solely to their strong performance since 2016.
o Historical P/NAVs for Intermediate & Junior Producers at Historical Low (Figure 3).
o Most Equities Have Recovered Little of What Was Lost in the Down-Cycle: (Figure
4).
o Sobering Truth – Gold Has Outperformed All Gold Equity Tiers Except Royalty &
Developers Since 2004 (Figure 5): Holding the metal will be a serious alternative to
owning the equities.
Necessary Pre-conditions
o Rally Must Be Perceived to Be Sustainable, or retracement will occur, rapidly (no
goodwill left with investors).
o Seasonal Head Fake? This could just be another seasonally inspired lift, maybe another
mini-rally like 2016 (7–8 months). Gold is inherently unpredictable, but we believe the
odds are that it will rise before this up-cycle ends and that the upside is substantially
more than the downside at this time. However, be prepared to trade.
o Producers Must Convey & Demonstrate Cost Discipline
Must convince investors that this cycle they will translate higher gold prices into
record EPS and cash flow, unlike last cycle (discussed in our Nov. 30 report,
What’s Working and What’s Not in the Gold Equity Market?).
Watch What Happens to Head Grades & Unit Costs in the Rally: We suspect 2019
cost guidance will be up, showing costs already under pressure.
o No Market Meltdown: If a broad market meltdown occurs, gold equities will also likely
sell off. Gold might too, initially, based on past experience.
Paradigm Capital Inc. | IIROC/TSX member Page | 3
Research Note
Gold Sector
RESEARCH NOTE | January 10, 2019
3. Current Rally Is Being Led by Large Cap – For Now
Current Uplift Dominated by Large Caps So Far: The current lift has seen the Senior,
Intermediate and Royalty tiers increase 24%, 18% and 15%, respectively in the past three
months (Figure 6). Gold is up 8%. The Junior producers are flat, while the Explorer tier is still
in negative territory at -5%. Developers are up slightly, 3%.
Timing the Tiers: Gold funds have limited capital, no inflows and suffered from their small-
cap exposure in 2018, so might collectively be slower to take up their historical practice of
moving down cap early on to maximize relative performance. How quickly the small caps
begin to perform will depend, we suspect, on the retail and generalist appetite and how
enticing the rally becomes versus technical and momentum measures. Retail Setting: Losses
in other sectors, including cannabis, might increase the gold sector’s appeal, now that gold
has some momentum.
2016 Rally Case Study (Figure 7): A short upward burst of gold and equity prices occurred
from Dec. 2015 to July–Aug. 2016. It saw the gold price increase 32%, from $1,051/oz in Dec
to peak at $1,382/oz in July. First movers were the Senior and Intermediate producers up
54% and 38% by mid-February (end of month #2). The smaller-cap gold equities lagged by a
few months, but by mid-March (end of month #3) had caught up and outperformed every
month thereafter until the rally began to fizzle in August (month #8). The Royalty tier
underperformed the other gold equity tiers, but quadrupled gold’s performance and held far
more of their gains after the rally, indeed being one of the only tiers to continue increasing in
2017 besides the Developers, and to hold onto their gains in 2018.
4. Where to Make Money in the Gold Equities
All Equity Boats Will Float – Only a Few Will Be Watertight
Best Safest Equity Bet: The Royalty Companies Will Beat Gold’s Performance
o Royalty companies have the best business model in the sector, by far
Able to create value in flat and weak markets
Still growing: Despite the increase in the number of Royalty companies and lack of
new developments, our discussions pre-Christmas found the Royalty companies
quite busy with new ideas.
o Historical track record of outperforming in up and down cycles: See the analysis in our
Nov. 30 report, What’s Working and What’s Not in the Gold Equity Market?
o Third best-performing tier in current upturn: Up 15% past three months, versus 18% for
Intermediates, 24% for Seniors (Figure 6).
o Favourite Royalty Companies: Franco-Nevada, Osisko Royalties, Sandstorm (top
pick)
Developers Provide the Best Torque, Explorers the Most Torque
o Acute shortage of new development projects and good exploration discoveries
o Yet selling for less than one-quarter of “replacement” cost: Currently <$30/oz mineable
resource.
o Developers and Explorers have dramatically underperformed the metal: Per Figure 4.
Developers have recovered only 17% of their losses from the previous cycle high,
Explorers only 14%.
o Developer tier: Has had second best historical performance among gold equities (Figure
5).
Takeover premiums (62% since 2014 for our Takeover Twenty Developers) provide
unique performance sizzle.
o 2016 rally experience – lag then outperform: Small caps lagged a few months, but
largely caught up by the end of the third month and continued to outperform the larger
cap (Figure 7) for the duration, even 3–4 months after the July–Aug. 2016 peak.
o Not hampered by cost inflation, unlike producers
o However, a wall of financings is likely and will dampen upside
o Favourite Developers: Cardinal, Orca, Orezone, Sabina. Note, however, that we
recommend almost all developers in our Takeover Twenty.
o Favourite Explorers: Cartier, Erdene, Moneta, Reunion*, Revival
Paradigm Capital Inc. | IIROC/TSX member Page | 4
Research Note
Gold Sector
RESEARCH NOTE | January 10, 2019
Junior & Senior Producers the Most Beaten Up, but Least Seaworthy
o Junior producers have only recovered 11% of losses during down-cycle
Too many junior producers – consolidation needed
Mergers of equals more likely than the big takeover premiums
o Senior producers have only recovered 15% of losses during down-cycle
Growth and reserve replacement are major concerns
o Cost concerns: Will history repeat itself? Historically, if gold prices rise, costs will rise
just as fast (R2 ≥ 0.92).
o Favourite Junior Producer: Dundee Precious
Intermediate Producers – Liquidity & Torque but Beware of Rising Costs
o Intermediates have already recovered more of their share price contraction in the
downturn than other equity tiers, except the Royalty tier, recovering 41% of their
decline versus an average of 14% for the other tiers (except Royalty tier) and 28% for
gold (Figure 5).
o Rising costs are likely to be the shoals that wreck the performance of this tier, if history
is any indication (relationship of cash costs per ounce to gold price R square is >0.92).
o Favourite Intermediate Producers: Agnico-Eagle and Semafo
Paradigm Capital Inc. | IIROC/TSX member Page | 5
Research Note
Gold Sector
RESEARCH NOTE | January 10, 2019
Figure 1: How Does this Gold Cycle Compare
Source: Paradigm Capital Inc., Bloomberg, FactSet
Cycle Duration (in years, starting with rally portion)
Sept 1976 -
May 1982
June 1982 - Feb
1985
March 1985 -
March 1993
March 1993 -
July 2001
July 2001 -
Nov 2008
Nov 2008 -
Dec 2015
Current Cycle
Dec 2015 -
Present
Up-Cycle Average Median
Duration Years (trough to end of crest) 3.4 0.6 2.8 2.9 7.0 3.9 3.1 3.4 3.1
Amplitude (% change trough to peak) 668% 71% 76% 25% 269% 152% 32% 210% 114%
Down-Cycle
Duration Years (crest to end of trough) 2.4 2.0 5.2 5.4 0.3 3.2 3.1 2.8
Amplitude (% change peak to trough) -65% -43% -33% -36% -27% -41% -41% -39%
Total Cycle
Duration Years (trough to trough) 5.8 2.7 8.0 8.3 7.4 7.1 6.4 7.2
Amplitude (% change trough to trough) 169% -3% 18% -20% 168% 48% 66% 33%
* Of the 6 full cycles one had a notably short rally (1982) and one a notably brief decline (2008), i,e, they were not in the same cycle..
The Up-Cycles (Rallies)
Sept 1976 - Jan
1980
June 1982 - Feb
1983
Feb 1985 - Dec
1987
March 1993 -
Feb 1996
July 2001 -
July 2008
Nov 2008 -
Oct 2012
Current Cycle
Dec 2015 -
Present
Average Median
Low Price $111 $298 $282 $333 $265 $710 $1,051
High Price $850 $508 $497 $415 $977 $1,790 $1,382
Increase from the Low % 668% 71% 76% 25% 269% 152% 32% 210% 114%
Duration of Up-Cycle (years) 3.4 0.6 2.8 2.9 7.0 3.9 3.1 so far 3.4 3.1
Average Price $292 $416 $392 $381 $492 $1,320 $3,258 $2,251
Low Date 14-Sep-76 22-Jun-82 25-Feb-85 10-Mar-93 5-Jul-01 12-Nov-08 17-Dec-15
High Date 21-Jan-80 14-Feb-83 11-Dec-87 2-Feb-96 15-Jul-08 4-Oct-12
Duration of Rally (months) 40 8 34 35 84 47
The Down-Cycles (Troughs)
Jan 1980 -
May 1982
Feb 1983 - Feb
1985
Dec 1987 -
March 1993
Feb 1996 -
July 2001
July 2008 -
Nov 2008
Oct 2012 -
Dec 2015
Current Cycle
Down-Cycle Has
Yet to Begin
Average Median
High Price $850 $508 $497 $415 $977 $1,790
Low Price $298 $288 $333 $265 $710 $1,051
Decline from High to Low -65% -43% -33% -36% -27% -41% -41% -39%
Duration of Down-Cycle (years) 2.4 2.0 5.2 5.4 0.3 3.2 3.1 2.8
Average Price $496 $398 $395 $308 $831 $1,312
High Date 21-Jan-80 14-Feb-83 11-Dec-87 2-Feb-96 15-Jul-08 4-Oct-12
Low Date 22-Jun-82 25-Feb-85 10-Mar-93 5-Jul-01 12-Nov-08 17-Dec-15
Duration of Trough (months) 29 24 63 65 4 38
Duration of Past 6 Cycles
Amplitude of 6 Past Cycle
Rallies
Amplitude of 6 Past Cycle
Troughs
Implied Current Cycle Peak Price
Paradigm Capital Inc. | IIROC/TSX member Page | 6
Research Note
Gold Sector
RESEARCH NOTE | January 10, 2019
Figure 2: TSEG vs Gold USD — Equities Now Recovering Lost Ground, Just Barely
Source: Bloomberg, FactSet
Paradigm Capital Inc. | IIROC/TSX member Page | 7
Research Note
Gold Sector
RESEARCH NOTE | January 10, 2019
Figure 3: Historical Intermediate & Junior P/NAV Multiple (5% DCF)
Source: Bloomberg, FactSet
0.20x
0.40x
0.60x
0.80x
1.00x
1.20x
1.40x
1.60x
1.80x
2.00x
$100
$300
$500
$700
$900
$1,100
$1,300
$1,500
$1,700
$1,900
$2,100
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Spot Gold Price (US$/oz) Gold Price Used for NAV Calculation (US$/oz) Intermediate P/NAV Multiple (%5 DCF) Junior P/NAV Multiple (%5 DCF)
Paradigm Capital Inc. | IIROC/TSX member Page | 8
Research Note
Gold Sector
RESEARCH NOTE | January 10, 2019
Figure 4: Most Equities Have Recovered Little of What Was Lost in the Down-Cycle & Less than Gold
Source: Bloomberg, FactSet
Paradigm Capital Inc. | IIROC/TSX member Page | 9
Research Note
Gold Sector
RESEARCH NOTE | January 10, 2019
Figure 5: Performance by Tier Since 2004
Source: Bloomberg, FactSet
Paradigm Capital Inc. | IIROC/TSX member Page | 10
Research Note
Gold Sector
RESEARCH NOTE | January 10, 2019
Figure 6: Relative Performance of Tiers — Past Three Months
Source: Bloomberg, FactSet
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Research Note
Gold Sector
RESEARCH NOTE | January 10, 2019
Figure 7: The 2016 Gold Rally – Largest Producers Performed Best at the Start
Source: FactSet
Dec 17 2015
Dec/15 to
Jan/16
(Month 1)
Jan/16 to
Feb/16
(Month 2)
Feb/16 to
Mar/16
(Month 3)
Mar/16 to
Apr/16
(Month 4)
Apr/16 to
May/16
(Month 5)
May/16 to
June/16
(Month 6)
June/16 to
July/16
(Month 7)
July/16 to
Aug/16
(Month 8)
Aug/16 to
Sept/16
(Month 9)
Sept/16 to
Oct/16
(Month 10)
Oct/16 to
Nov/16
(Month 11)
Nov/16 to
Dec/16
(Month 12)
Gold (US$) $1,051 $1,089 $1,238 $1,258 $1,234 $1,279 $1,299 $1,338 $1,349 $1,310 $1,256 $1,216 $1,135
% Change 4% 14% 2% -2% 4% 2% 3% 1% -3% -4% -3% -7%
Seniors 4% 48% 10% 12% 15% 1% 13% -2% 17% -9% -7% -15%
Intermediates 3% 34% 12% 15% 20% -1% 17% -1% 12% -11% -8% -13%
Junior Producers 1% 30% 31% 25% 16% -1% 19% 0% -7% -10% -13% -18%
Royalty -5% 16% 15% 8% 18% 2% 15% 5% -9% -8% -5% -4%
Developers < 3yrs w/o prod. 3% 15% 24% 31% 32% 15% 15% 7% -10% -1% -13% -14%
Developers > 3 yrs w/p prod. 0% 20% 38% 30% 23% 0% 18% 11% -7% -10% -11% -14%
Explorers 5% 13% 30% 24% 24% 15% 21% 19% -4% -7% -13% -7%
Monthly Change from Cycle Low Dec 17, 2015
1 Month 2 Months 3 Months 4 Months 5 Months 6 Months 7 Months 8 Months 9 Months
10
Months
11
Months
12
Months
Gold (US$)
% Change 4% 18% 20% 17% 22% 24% 27% 28% 25% 19% 16% 8%
Seniors 4% 54% 69% 90% 118% 120% 149% 144% 185% 160% 142% 105%
Intermediates 3% 38% 55% 78% 113% 111% 147% 145% 174% 144% 124% 95%
Junior Producers 1% 31% 72% 115% 149% 147% 194% 194% 173% 146% 114% 75%
Royalty -5% 10% 27% 37% 62% 65% 89% 99% 81% 67% 58% 52%
Developers < 3yrs w/o prod. 3% 18% 47% 92% 154% 192% 236% 259% 223% 220% 179% 140%
Developers > 3 yrs w/p prod. 0% 20% 66% 115% 165% 165% 212% 247% 223% 190% 158% 122%
Explorers 5% 19% 54% 91% 137% 173% 230% 293% 277% 251% 205% 184%
Cumulative Change From Cycle Low Dec 17, 2015
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Research Note
Gold Sector
RESEARCH NOTE | January 10, 2019
DISCLAIMER SECTION
Company Ticker Disclosures
Agnico-Eagle Mines Ltd. AEM-T 3
Cartier Resources Inc. ECR-T 3
Dundee Precious Metals DPM-T 3
Erdene Resources Dev. Corp. ERD-T 2,3
Franco-Nevada Corp. FNV-T 3
Orca Gold Inc. ORG-T 3
Orezone Gold Corp. ORE-V 3
Osisko Gold Royalties OR-T 3
Reunion Gold Corp. RGD-V 3
Revival Gold Inc. RVG-V 3
Sabina Gold & Silver Corp. SBB-T 2,3
Sandstorm Gold Ltd. SSL-V 3
Semafo SMF-T 3
Note: Please refer to above table for applicable disclosure numbers.
1. The analyst has an ownership position in the subject company.
2. Paradigm Capital Inc. has assumed an underwriting liability for, and/or provided financial advice for consideration to the subject companies during the past 12 months.
3. Paradigm Capital Inc. expects to receive or intends to seek compensation for investment banking services from the subject companies in the next 3 months.
4. Paradigm Capital Inc. has greater than a 1% ownership position in the subject company.
5. The analyst has a family relationship with an Officer/Director of subject company.
Paradigm’s disclosure policies and research distribution procedures can be found on our website at www.paradigmcap.com. Paradigm Capital Inc. research is available on Bloomberg, CapitalIQ, FactSet and Thomson Reuters or at www.paradigmcap.com. Issued by Paradigm Capital Inc.
Research Rating System
Paradigm Capital Inc. uses the following rating recommendation guidelines in its research:
About Paradigm Capital Inc.
Paradigm Capital Inc. (PCI) is a research-driven, independent, institutional equity investment dealer focused on sectors and companies that have attractive long-term secular growth prospects. PCI’s research is available on our website at www.paradigmcap.com. Please speak to your Sales or Trading Representative if you require access to the website.
The analyst (and associate) certify that the views expressed in this report accurately reflect their personal views about the subject securities or issuers. No part of their compensation was, is, or will be, directly or indirectly, related to the specific recommendations expressed in this research report.
Analysts are compensated through a combined base salary and bonus payout system. The bonus payout is determined by revenues generated directly or indirectly from various departments including Investment Banking, based on a system that includes the following criteria: reports generated, timeliness, performance of recommendations, knowledge of industry, quality of research and investment guidance and client feedback. Analysts are not directly compensated for specific Investment Banking transactions.
The opinions, estimates and projections contained herein are those of PCI as of the date hereof and are subject to change without notice. PCI makes every effort to ensure that the contents herein have been compiled or derived from sources believed reliable and contain information and opinions, which are accurate and complete. However, PCI makes no representation or warranty, express or implied, in respect thereof, and takes no responsibility for any errors and
Number of Percentage
Recommendation Companies Breakdown
Buy 93 62% Buy – Expected returns of 20% or more over 12 months.
Spec. Buy 35 23% Speculative Buy - Expected returns of 20% or more over the next 12 months on high-risk development
or pre-revenue companies, such as junior mining and other early stage companies.
Hold 14 9% Hold - Expected returns of less than +/- 20% over the next 12 months.
Sell* 5 3% Sell - Expected returns of -20% or more over the next 12 months.
Total 147
*Includes companies with a "Tender" recommendation
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Research Note
Gold Sector
RESEARCH NOTE | January 10, 2019
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