Precious Metals: Q4/21 Preview and 2022 Outlook
Political Tensions and Inflationary Concerns Buoying Gold Price
Gold posted a mixed and volatile performance in 2021, moving from a high of just under $1,960/oz in the early days of 2021 down to a low of $1,677/oz in late- summer, and back to a high of nearly $1,875/oz in mid-November, before falling back to below the $1,800/oz range. The gold price averaged $1,796/oz in Q4/21, a slight uptick from $1,790 in Q3/21.
Further political tensions or rate-hike delays should support a higher gold price. Recent political tensions between Russia and Ukraine have helped lift the gold price early in the new year. Clearly, if the Russia-Ukraine tensions intensify, gold could continue to benefit, potentially breaking out of its recent trading range. Political risks associated with the pending U.S. mid-term elections, U.S. fiscal drag, sustained central bank gold purchases, and a significantly slower pace of U.S. and global economic recovery in 2022 are additional factors that we believe should see investors rekindle their interest in gold after a disappointing 2021. We expect that these factors should help lift gold into the $1,875-$1,900/oz range in H1/22; we are maintaining our $1,850/oz gold price forecast for 2022.
Producers are warning on opex and capex inflation in 2022. Of the gold producers who have provided 2022 cost guidance, we have seen an average operating cost increase (cash costs) of ~6% (range of 0-20% increase). In addition, we are expecting capex inflation of 15-20% y/y. Labour shortages, higher input and energy costs, and supply-chain challenges are the main drivers behind the inflationary pressure.
Strong cash-flow generation. Despite these cost-inflation concerns, we believe that the producers are better-positioned to absorb inflationary pressure than they were a decade ago. Management teams have sustained a sharp focus on cost control; they have not chased lower-grade marginal ounces. We expect that the producers will continue to generate strong FCF. The average FCF yield for our 10 largest producers is 10.1%. They also continue to pay healthy dividends (the average dividend yield is 2.8%), which we expect will remain stable over the year.
We are maintaining our OVERWEIGHT sector recommendation. Our view is weighted towards H1/22, given that we expect interest-rate normalization by central banks to gain more traction in H2/22. Given opex and capex inflation concerns, we also expect that investors will continue to favour royalty companies for precious metal exposure, as was the case in 2021. Our ACTION LIST BUY pick for the sector remains Barrick Gold. Our top picks among the mid-cap and small-cap golds are SSR Mining and K92 Mining, respectively. Among the silver names, our top pick is Pan American, and we continue to prefer Franco-Nevada and Triple Flag Precious Metals among the royalty names.