Will easing cost concerns give a boost to mining stocks?

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Rising costs have been an issue for many sectors, including mining. But are there some signs that those pressures may be easing? Joining us now to discuss is Craig Hutchison, director for equity research at TD Cowen.

Craig, welcome to the program. Your first time here.

Yeah. Thanks for having me on the show.

All right. Before we jump into the meat of the matter, tell me a little bit about your coverage area.

So I cover the junior base metals, for the most part, a number of copper names, cover some silver, and I cover uranium and some iron ore names.

OK. So these definitely names, as we hinted to in the beginning, that would have been feeling the pressures of cost inflation, like so many industries. Tell me a bit about that, what they had gone through, and where we might be headed.

Yeah. So if you look back about three years ago, the start of the pandemic, you had a lot of supply chain disruptions. You layer on the fact that we had the war in Ukraine. The supply disruptions have been across the industry for the past couple years. You've had issues around sulfuric acid supply, explosives, diesel prices. So all that's contributed to very high inflation in the mining area specifically.

So if you look back, say, last year, mining inflation costs are around maybe up 10%. That is starting to come off the boil now. Most companies are sort of guiding to inflation to be up sort of in that 3% to 5% range. So still high, still probably above CPI, but it has come off.

Some of those factors are just Forex currencies are starting to come off just relative to the US dollar. But it's still an issue, particularly in the North American markets. It's very difficult, as you can imagine, to get miners to go to these sites, right? It's just, it's a very tight labor market. And so you're competing against other industries, like the oil and gas. So it's been very difficult to kind of secure people in places like North America and Australia, where the markets are very tight.

OK. It's an interesting backdrop there. We've had some questions from people who watch these programs saying they take a look at, say, the rally in the price of gold. And we could be talking about maybe any metal that's been in a rally lately. Then they look at the actual stocks connected to the underlying commodity and they wonder why they're not fully participating. Is cost inflation part of that story?

Absolutely. So if you look back last year, the average price for gold, I think, was 1940. So it was up 8% year over year. But costs were up almost the same amount. So margins have remained flat despite a rising gold price environment. So I think for the equities to participate, you need to see that margin expansion happening.

We think that will happen if gold starts to rise, if the Fed starts cutting here later this year, which is our expectation. And it's been, I guess, challenging for gold also is competing against other asset classes. It's competing against the S&P 500, which was up, I think, 25% last year. It's competing against Bitcoin. It's competing against even money market funds, which are earning, say, 5%, and gold doesn't give you an earnings yield.

So you have to basically-- gold will outperform in inflationary environments and outperform when real rates start to fall. And we think real rates will start to fall as interest rates start to get cut later this year.

Let's talk about that interest rate path and the delivery of cuts later this year, which is the expectation. When it comes to the equity side of things, you always try to wonder, how much of it was already priced in and how much room do you have to run. So when it comes to the price of gold, how much of that expectation of cuts have been priced in, do you think? Or do you think once the cuts arrive, gold continues to move?

Yeah, so we've done some work on that. We've looked back at previous cycles over the last 40 years. And on average, gold tends to rally around 34% when the Fed starts to make those first cuts-- or, I guess when the last hike was done. And so the last hike was, I think, July of last year. And since that point, gold has rallied 10%. So I still think there's a long way to go for gold.

But the issue has been, I think the expectations for rate cuts have been, they keep coming and they haven't happened so far.

A little dialed back from where we entered the new year.

Right. We should have been-- if you look at the consensus view, we should have had rate cuts last year, right? And I think TD's view right now is for three cuts this year, so 75 basis points this year, 75 basis points next year. But the expectations around that keep getting pushed out. I think the latest is now June or July.

So I think we need to see those actual rate cuts to really see the gold price move, but I still think there's more upside from where we are right now.

All right. So that's gold. Let's talk about copper. We've been seeing some movement in copper as well.

Yeah. I mean, copper has obviously got some good supply-demand dynamics. We could talk about that more. One of the issues I think with copper is interesting, just in terms of what is the incentive price to bring on new supply. And that's something that's come up when we're talking about inflation. If you look back a few years ago, I think the incentive price for copper to generate a decent return on a project was probably around $3.50 per pound.

Today, that incentive price is probably north of $4.50 to $5.00 a pound. And what that means is a lot of projects aren't going to get sanctioned at these current prices. So we need to see prices move higher in order to incentivize new supply. And the positive aspect of that is those who are producers now, you're not going to see a flood of new supply coming on the market. So I think the price of copper will hold firm here, just given the fact that the supply-demand dynamics are going to be positive and pretty tight for the foreseeable future.

When it comes to central bank rate cuts, is copper as sensitive? I imagine gold would be the most sensitive, but other commodities.

Yeah. I mean, if it results in a US dollar weakening, that's usually a positive for the commodities more broadly. But if the Fed is cutting because the economy is slowing, copper is heavily tied to global GDP, that's not a strong thing. That's not that's not great for copper. But if it's more of a soft landing and we start to see some stimulus happening in China, that obviously-- that would really spur copper prices to go higher.

All right. We got gold. We got copper. Let's talk about uranium. This has been another space that's been very interesting this year in terms of the moves that we've seen. Where do we think we might be going forward here?

Yeah. No, it's certainly been very topical. I think the fundamentals for uranium are probably the best they've been in 15 years, going back to the Fukushima disaster. If you go back to, say, 2018, uranium prices were under $20 a pound. And some of the big producers in the world, like Cameco and Kazatomprom, took leadership. They curtailed production. That took a big step to tightening up supply.

And then if you move forward a couple of years after that, we had a bunch of ETFs come to the market and start to acquire pounds. And they've taken out almost 60 million pounds in a 180 to 200 million pound a year market. So that's pretty substantial. So they've tightened up the market.

Uranium touched over $100 a pound about two months ago. It's come back a little bit. But I think if you just look at the overall demand that you're going to see going forward, I see the first time in my career where you've seen governments unilaterally sponsoring uranium. The COP28 conference a couple months back, you had 22 different countries coming out and supporting nuclear, pledging to triple their nuclear capacity by 2050, including Canada and the US. And you have bipartisan support in the US, both with Biden and potentially Trump, if he gets back in power.

So I know there's always concerns about what would that mean if a Trump administration, Biden administration. You do have support across, and the US is still the largest producer of nuclear power in the world.

OK. TD Cowen covers Cameco. And for full disclosure on the companies covered by TD Cowen, a division of TD Securities, please see the link to the TD Securities website at the end of this program.

I want ask you one more question before we finish this part of the chat, in terms of nuclear. What's the biggest risk here? Is the risk that governments somehow turn away from it?

Yeah. I mean, if there is another sort of black swan event, if there's another Fukushima or an issue maybe in Ukraine, that obviously would derail it. But I guess the rise of renewable powers has cut into nuclear demand and the outlook in the past. But I think the view is that the wind doesn't always blow and the sun doesn't always shine. So for baseload no carbon intensive power, there is no substitute for nuclear. [AUDIO LOGO]

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