Market Commentary- Metals Team November 2021

14 December 2021

Market Commentary November 2021 by Georges Lequime

November proved to be a volatile month for the Fund. All three major sectors that the Fund is invested in initially performed strongly up until the US released the high 6.2% CPI figure on November 11. At this point, US officials vowed to take action to curb surging prices which increased the market’s expectations of a short-term rate hike. This led to a surge in the relative performance of the US dollar and a pullback in precious metals and industrial commodity prices. The discovery of the Omicron variant did not seem to affect the market’s expectation about the timing of the imminent tapering by the Fed, as well as expectations about upcoming interest rate hikes.

Figure 1: Market Expectation of the probabilities of rate hikes in 2022.

Source: Capitallight Research

While tighter monetary policy (less monetary stimulus coupled with rising real rates) should be negative for precious metal prices, this assumes that inflation is indeed transitory and it dismisses any impact of the Omicron coronavirus strain on the global economy. Tighter monetary policy and inflation should also be a concern for industrial metal prices. It is our opinion that all the possible negative scenarios for gold and silver are already baked into in the precious metal prices, while the opposite can be said about industrial metal prices where we see the risk of a slowdown in global growth being a threat to short-term prices. It is interesting that precious metal equities are already discounting precious metal prices some 20-30% lower than spot, while industrial metal equities are either fairly priced, or aggressively priced, by the market based on spot prices.

Even with the risk of a slowdown in the global economy, the Fund is well placed through seeking investments in those companies that are expected to grow in value irrespective of whether metal prices are lower in the short-term. Of frustration to us, is the lack of appetite for precious metals equities where a large number of the companies that the Fund is invested in are trading at sustainable free cash flow yields in excess of 20% and EV/EBITDA ratios of 3x or less – the lowest multiples in decades. We believe that we are in a transitory phase right now as far as the outlook for the global economy is concerned with the imminent start of tapering in the US and Europe. This is causing undue volatility in the sector which is resulting in very low investor appetite for the sector and low trading volumes. 

What is certainly not helping investor appeal is an apparent rise in geopolitical risk in Latin America. On November 11, Fortuna Silver (one of our largest investments) was told that its San Jose mine in Mexico faced a potential closure next year due to an expired permit. This sent the share price down 30% despite the mine contributing to roughly 18% of the company’s value and with the company have a very strong balance sheet and with strong cash flow generation from their other three mines. Less than two weeks later, Hochschild’s received notice that its two mines in Peru faced closure. This sent their shares down 27%. While matters seem to have been cleared up in Peru, the shares remain heavily discounted by the market.