The last few days saw wild moves in the markets, particularly for the dollar and gold. Wednesday saw the Federal Reserve meeting, followed on Thursday with rate hikes from the European Central Bank and Bank of England, and then on Friday, before the market opened, the unexpectedly strong labor report.
- Stocks initially fell a little on the Fed statement, calling for “ongoing increases” in rates, then jumped on Chairman Jerome Powell’s more dovish press conference, to pull back just a little on Friday.
- The dollar was sharply down after Powell’s press performance, ignored (surprisingly) the European and U.K. rate hikes, and shot up on the employment report.
- Gold was up after Powell’s comments, after dropping a little on the Fed statement, then it fell on the overseas rate hikes, and again after the employment report, giving up US$100 in the last two days of the week.
The Market Saw Powell as More Dovish
The market had been expecting Powell to push back against the markets seemingly ignoring the Fed’s warnings on tighter conditions. But in the end, despite trying to sound hawkish and saying that the Fed was “not yet sufficiently restrictive,” he was unconvincing and more dovish relative to what people had been expecting.
After saying that inflation had eased, he said that the “disinflationary process” is underway. Powell, in his press conferences, has a habit of saying too much, rather than sticking with his central message, and markets latch on to the parts they want to hear.
How Valid Was the Employment Report?
The employment report suggested more than twice as many jobs were added in the last month as expected, with the unemployment rate down to the lowest level in decades. Since that would counter the Fed’s wish for labor conditions to ease, it suggests that the Fed would be tighter for longer. However, the January report is prone to exaggerate seasonal adjustments, while there is a new population adjustment to the report which could have made it appear stronger than otherwise.
Nonetheless, more jobs were added than expected.
We had commented before about the discrepancy between the two Bureau of Labor Statistics reports, the household and the payroll. Interestingly, the household survey numbers, which had been significantly weaker than the payroll report, suddenly shot up in the last couple of months as more and more commentators started questioning how the two BLS reports could be so different. (Coincidence? Call me cynical.)
So given the outlook I am expecting, namely continued inflation (if at a reduced pace), a slowing economy, and a slowing rate of interest rate hikes, we should not be surprised to see weaker stocks and stronger gold.
Significantly, although the government report was the strongest in six months, the private ADP survey was the weakest in two years. Notwithstanding the differences in what the two reports measure, there is a wide and growing discrepancy that needs explaining.
Lastly, the employment report is a lagging indicator. Unemployment is usually at its lowest immediately prior to a recession. So the apparent strength in the labor market does not preclude a recession later this year. Other strong recession indicators — such as the inverted yield curve, twice as wide as before the global financial crisis; or the Leading Economic Index, which continues to trend downwards — point to a recession.
Stocks Have Further To Fall if Earnings Disappoint
It should be emphasized that a pause in Fed tightening is not necessarily bullish for stocks (except perhaps in the immediate term). The bear market is not over. According to James Stack, on average, the majority of bear market declines come after the final Fed hike. We can add that bear markets usually do not end at 18 times earnings.
Stock earnings are slowing; there have been disappointing earnings from Alphabet (Google), Amazon, and Apple . . . and that’s just the “A’s.” Yet analysts' consensus earnings estimates suggest a less than half a percentage decline in earnings in the year ahead. And interestingly, analysts are raising their price targets; 100 companies in the S&P 500 now have increased consensus targets, compared with only 25 in October.
In addition, gold and gold stocks typically perform well during recessions. So given the outlook I am expecting, namely continued inflation (if at a reduced pace), a slowing economy, and a slowing rate of interest rate hikes, we should not be surprised to see weaker stocks and stronger gold.
Fortuna Sees Bad News and Good News at Different Mines
Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE) announced a large reduction in reserves at its Yaramoko mine in Burkina Faso, cutting potentially mineable material by 166,000 ounces. The company said this was due to a surveying error in 2020 before Fortuna acquired the mine. The mine’s reserves now stand at 263,000 ounces of proven and probable, with a further 120K in the measured and indicated, and inferred categories.
The company also announced that the Séguéla project in Cȏte d’Ivoire is on schedule for mining activities to commence this month, with commissioning in the second quarter of this year. With many projects around the world seeing significant cost overruns and delays, it is a remarkable achievement for Fortuna to build a new mine on time and on budget.
Separately, the company received a provisional injunction from a federal court in Mexico to allow it to continue to operate the San Jose Mine under the terms of its 12-year extension. Earlier this year, the Mexican environmental agency, SEMARNAT, headed by an anti-mining activist, had revoked (again) the permit in a year-long fiasco.
The court is expected to decide on a permanent injunction in the coming weeks, before ruling on the license revocation itself, which would take longer. We are cautious for the immediate term on the gold and silver stocks, given that there could be further pullback in the metals prices. But Fortuna is one to buy on any additional pullback.
Altius Sees Record Year and Growth Ahead
Altius Minerals Corp. (ALS:TSX.V) reported a decline in royalty revenue for the fourth quarter, but still achieved record revenue for the year. The company reported CA$23 million for the quarter, and CA$103 million for the year, up 23% from 2021 revenue. Potash was a contributor to the softer fourth quarter, though it drove the record annual revenue, more than double the prior year on the back of the Russian invasion of Ukraine. Base and battery metals also fell throughout the year, including the fourth quarter.
In the coming year, there are several key milestones for projects on which Altius holds royalties, including an updated feasibility study from Champion Iron on the Kami iron-ore project; and a pre-feasibility study from AngloGold on its Silicon Project in southern Nevada. The PFS will cover the Silicon Central deposit, while it will also publish a maiden resource estimate for the adjacent Merlin deposit. (Another of the companies on our list, Orogen, also holds a royalty on part of this project.)
The company is also expecting a continued ramp-up of revenue from Altius Renewal Royalties, in which Altius holds about 50% of the shares.
Altius is one of our core holdings, offering exposure to a broad range of commodities as well as strong, innovative management.
We are holding but will look for opportunities to add to positions.
Lithium Boosts Midland
Midland Exploration Inc. (MD:TSX.V) saw its stock price soar after announcing it had completed a full re-evaluation of its properties in the James Bay area for their lithium potential, amid a staking rush for lithium and stock mania.
Midland has 3,814 claims totaling 1,975 square kilometers, in the James Bay area, making it one of the largest claim holders in the region. Four projects were identified as highly prospective for their lithium potential, based on “striking geological similarities” with adjacent lithium discoveries and “compelling occurrences” of lithium and associated minerals. In particular, its work includes a geological assessment of the “excellent” lithium potential on its Galinée project, four kilometers east of the new lithium discovery by Winsome Resources.
The map shows that Midland’s properties are very well located, near, often adjacent to, recent lithium discoveries. In November, the company optioned its Mythril and Elrond properties for lithium exploration; we would expect to see more such transactions over the coming year. It should be noted that none of these properties has been methodically explored for lithium.
Midland is smart to evaluate for lithium in an area known to be prospective, and smart to publicize that. It will likely look to seek partners for its lithium exploration since it is not the company’s main focus or expertise. In the current hot market, it could likely execute attractive deals. Separately, Midland will have an active year, with over CA$11 million in exploration budgeted, CA$7.5 million of it from partners.
In the last bulletin, 849, I noted that Midland was planning 2000 meters of drilling this year. That should be 20,000 meters. Though we like Midland as one of our top exploration plays and have been pounding the table over the past year, we would wait until the stock has settled back a little from its 100% move over the past two weeks before adding to positions.
Orogen Had an Active Year and Expects Another One
Orogen Royalties Inc. (OGN:TSX.V) reported on its 2022 generative work, which included eight option and sale agreements, mostly in Nevada as well as in British Columbia and Mexico, with a total of 16 currently active exploration partnerships.
Partners spent CA$5.6 million on exploration, including three drill programs. The company generated around CA$620,000 from its prospect generator business, including gains from the sale of projects. (This figure excludes their royalty income.) In the coming year, eight partner-funded drill programs are expected.
Orogen continues to execute its business model, generating projects and selling in exchange for exploration expenditures and royalties, while revenue from its Ermitaño royalty covers its G&A. It is well funded with solid management.
Corporate Transactions Ahead?
However, we anticipate some form of corporate transaction this year or next involving its key asset of a 1% royalty on AngloGold’s Silicon project. Altius, as per above, holds a 1.5% royalty on Silicon as well as other deposits in the area. The exact “area of interest” included is subject to an arbitration proceeding.
Any transaction could come in many forms, including a merger of Orogen with Altius’s gold interests, and potentially another small royalty company or royalty asset, to form a mid-sized, self-financed, royalty generation business. Alternatively, a third company could acquire Altius’ gold royalties and Orogen, or there could be a straight sale of the two Silicon royalties to a larger royalty company. All of these possibilities come with their own challenges, but all are clearly under consideration by various parties.
As per recent weeks, we are buying little, given the broad market’s overvaluation and gold’s vulnerability to a further pullback. However, several stocks are close to Buy levels.
Altius has announced its intention of divesting its gold assets which are outside of its corporate mandate. It clearly makes sense to put together the two royalties on Silicon, and such a combined royalty would form a cornerstone asset for any gold royalty company, given the prospectivity, the strong partner, and the tier-one jurisdiction.
Orogen and Altius are already closely aligned, with a strategic alliance seeking new projects in Nevada. Altius is also Orogen’s largest shareholder at 20%. We would expect the companies to wait for AngloGold’s new reports on Silicon (see above), and also the results of the Anglo-Altius arbitration which should be later this year (though that could be taken care of with contingency arrangements based on the outcome). We don’t know how this will end, though it is logical to put both Silicon royalties together.
We have had Orogen as a “best buy” for some time, and even after the end-of-year jump in the stock price from the 40-cent range to 50, we continue to accumulate. It is a buy at the current level.
Gladstone Offers a 10% Yield
Gladstone Investment Corp. (GAIN: NASDAQ) reported a strong quarter, with both adjusted Net Investment Income and Net Asset Value up. The company had previously announced an increase in its monthly dividend as well as a large special distribution to be paid in March. At the new rate and a projected number for the special distributions, the forward yield is over 10%.
Total investments increased, with a recapitalization of one portfolio company and an addon investment to another. Gladstone has low leverage with sufficient liquidity available but noted that the market for new deals was still “frothy” with high valuations amid strong competition. Valuation on the existing portfolio declined slightly, due mostly to lower multiples being ascribed to companies. One additional company moved to nonaccrual status, though Gladstone believes it will resume paying interest in the next couple of months.
There are now three companies on nonaccrual. President David Dullum said the companies were generally performing well, despite rising interest rates
and high inflation, and expected that to continue. We are holding. ERRATUM In Bulletin 848, in the discussion on negotiations between the Panama
government and First Quantum over the Cobre Panama mine, I noted that the company had agreed to the government's demand for a minimum payment of US$375 per year. That should of course have been US$375 million.
BEST BUYS: As per recent weeks, we are buying little, given the broad market’s overvaluation and gold’s vulnerability to a further pullback. However, several stocks are close to Buy levels.
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