By Joe Foster – Portfolio Manager and Strategist
US dollar strength continues
Gold fell below an important technical level of US$1,800 per ounce in the first week of July, succumbing to relentless strength of the US dollar as global recession fears drove investors to the greenback. Inflation data was, once again, ahead of estimates, as June’s US Consumer Price Index (CPI) accelerated to 9.1%, its largest year-over-year gain since 1981. Dollar strength and a corresponding technical break in gold was commensurate with expectations for more aggressive inflation-fighting rate hikes by the U.S. Federal Reserve Bank (Fed), rising June US retail sales (of 1%), and better-than-expected July consumer sentiment. Gold traded as low as US$1,681 on July 21 before bouncing back above US$1,700 per ounce. The metal eventually found some buyers following the Fed’s announced 75 basis point rate hike for July, with some strong follow-through the next day as data showed the U.S. economy contracting for a second straight quarter. Gold closed at US$1,765.94 per ounce on July 29 for a monthly loss of US$41.33 (-2.29%).
The NYSE Arca Gold Miners Index (GDX Index) was down 6.02% in July. Overall, gold equities continue to lag bullion, on the 12 months to 31 July 2022, the price of gold has risen 2.86% (in Australian dollar terms), while the GDX Index has fallen 19.45% over the same period.
Challenging start to earnings seasons
Newmont kicked off gold miners earnings season with, relatively disappointing second quarter results. The company revised its 2022 full year guidance to reflect the impact of higher costs for labor, materials, consumables, fuel and energy, with all-in sustaining costs for the year now estimated at US$1,150 per ounce (up from US$1,050 previously). A diagram from its quarterly earnings presentation below helps illuminate the source of some of its cost increases.
Operating costs increased across the board for Newmont
Source: Newmont. Data as of June 2022.
The company also revised its 2022 gold production guidance downward from 6.2 to 6.0 million ounces, to account for the impact of COVID related interruptions and delays, supply chain disruptions and a tight labor market particularly in Australia and Canada. In addition, due to the same pressures, Newmont had to increase its budget for several capital projects and push back its planned startup date which, in turn, impacted its longer term production guidance. Overall, the report did not read well and the company’s stock price took a 13% dip on the day it was released.
It’s not all that bad
Encouragingly, Newmont still generated US$1 billion of cash from operations, US$514 million of free cash flow and declared a quarterly dividend of US$0.55 per share (equating to a 5% dividend yield). As of quarter end, the company had US$4.3 billion in cash and a respectable net-debt-to-EBITDA ratio of 0.3x.
In general, many other gold mining companies have struggled with cost increases as well and we believe that Newmont’s update, overall, highlights both the challenges as well as the relative strength and healthy financial position that many companies in the sector find themselves in. And, to be fair, despite sector-wide challenges, there have been an abundance of other positive surprises in the second quarter reporting season.
For example, senior producer Agnico-Eagle delivered a solid earnings-per-share (EPS) beat, on the back of better than expected production and costs for the second quarter, and the company maintained its original operating guidance for 2022. Yamana Gold and Alamos Gold also reported solid results, with second quarter costs in-line with estimates, and unchanged guidance for 2022.
Where to now?
Strong US dollar performance has been weighing on gold this year. However, the US Dollar Index is down 2.5% since mid-July, perhaps giving gold a chance to reclaim its spot as the safe haven asset of choice. We are encouraged by gold’s recent resilience, and expect it to continue to trade around these levels in the shorter term. Although the Fed seems committed to its rate-hiking program, Chairman Powell’s comments on 2.25%-2.50% as a “neutral range” for the Fed funds rate does raise some questions on how much further they might go.
On the other hand, markets still seem undecided as to whether this program will tame inflation or drive the economy into a recession. Some participants speculate that the US economy is already in a recession; others anticipate that inflation is set to come down. Either scenario seems to support a sooner-than-previously-expected end to the Fed’s tightening cycle which we view as a strong catalyst to the gold price. We do believe the Fed will likely have to stop hiking rates as the economy contracts, but we also think that there is a significant risk that inflation remains at elevated levels for longer than anticipated. This would keep real rates in negative territory and be supportive of higher gold prices.
Gold and gold stocks are oversold. Though inflows, albeit small, into the gold bullion backed ETFs in the last days of July and early August may be signaling the end to persistent outflows since April of this year, and the beginning of stronger investment demand.