CGAU - Centerra Gold: Strong Downward Pressures Ahead Due To Challenging Context

2023-05-03 04:48:21 ET

Summary

• The future does not seem to bode well for Centerra Gold Inc, a Canadian gold and copper explorer and producer.
• It is estimated that gold and copper prices will fall in 2023. There will not be further momentum for the yellow metal as a safe haven asset.
• China's halt to recovery is a major problem for copper demand.
• Investors should be aware that this stock is highly exposed to fluctuations in commodity markets, which could amplify falls in the metals prices.
• The company is also facing some operational issues that will likely result in lower production and higher costs in 2023.

This analysis supports a Sell recommendation for Centerra Gold Inc. ( CGAU ) ( CG:CA ) stock for the reasons outlined in the article. My previous coverage on Centerra also supported a sell rating.

How Has the Centerra Gold Inc. Stock Price Performed Lately and Why?

Gold was somewhat popular in March as its qualities as a hedge against the risk of a major banking crisis were recognized following the collapse of Silicon Valley Bank (SIVBQ) and Signature Bank (SBNY).

As a result, the price per troy ounce of the precious metal traded through Gold Futures - June 2023 (GCM3) has risen by about 13% since the start of the US regional banking crisis, hitting a yearly high of $2,048.60 an ounce on April 13, 2023. Gold prices then gave back some of the accumulated gains as fears of a banking crisis eased after central bankers assessed the resilience of the banking system and JPMorgan Chase & Co.'s ( JPM ) takeover/bailout of the ailing First Republic Bank (FRC).

Gold-backed securities saw a similar trend in financial markets, including Centerra Gold Inc. ( CGAU ) ( CG:CA ) shares. While this stock is not only exposed to the gold market but also to the copper markets, gold drives most stock price fluctuations as it is the largest contributor to corporate earnings.

Centerra Gold Inc., based in Toronto, Canada, produces and sells gold, copper and holds a molybdenum business unit conducting mineral operations in North America and Anatolia.

Centerra Gold Inc. shares trade on the New York Stock Exchange [NYSE] under the symbol CGAU and on the Toronto Stock Exchange [TSE] under the symbol CG:CA.

Buoyed by the rise in gold prices amid fears of a banking crisis, CGAU shares peaked at $7.67 apiece on the NYSE on April 13 before falling back, losing 11.7% to $6.77 as of this writing.

CG:CA had the same move on the TSE in the sense that the shares peaked at CA$10.26 on April 13 and then the price declined 9.8% to sit at CA$9.25 at the time of this writing.

About Centerra Gold's future trend in both markets, the shares are likely to continue to track the price development of the main commodity gold and to some extent also copper, mimicking the past, which is shown in the below charts including the correlation coefficient [cc].

Centerra Gold Share Price and Its Positive Correlation With the Metals

CGAU is positively correlated with Gold Futures - June 2023 (GCM3) and Copper Futures - July 2023 (HGN3), albeit much more strongly with gold price action. The positive correlation of CGAU to GCM3, doubling the positive correlation of CGAU to HGN3, implies that CGAU stock price trends are remarkably more similar to gold prices than copper.

The chart below shows similar correlation trends between CG:CA and gold futures or between CG:CA and copper futures.

One wonders if gold is also the strongest determinant of changes in CGAU's stock price, because if so, an analyst estimate of the future price of gold could provide a clue as to how the stock might perform.

To this end, a linear model, in which CGAU is a function of gold or copper price, showed that, on average, a one US dollar fall (or a $1 jump) in the price of gold results in a nearly $2 loss (or $2 gain) in the stock price of CGAU. While a $1 fall (or a $1 rise) in the copper price results in an almost $0.60 fall (or a $0.60 rise) in CGAU's share price.

Thus, CGAU stock has a gold beta of 1.9x and a copper beta of 0.6x.

The model has been run over the last 52 weekly returns on CGAU stock and on gold futures or copper futures and not further back, as the upcoming period appears poised to look similar to what we have seen over the past year. The choice is justified by the observation that the markets are likely to be under the influence of the same macroeconomic and geopolitical factors, such as higher interest rates against runaway inflation and the aftermath of the war in Ukraine.

Similar parameters were obtained when the output or dependent variable of the linear model was the weekly returns of CG:CA stock instead of CGAU.

Therefore, with analysts forecasting that both gold and copper prices will fall in an environment unfavorable for the two metals, Centerra Gold shares are unlikely to show an opposite trend and may potentially suffer significant losses based on the estimated parameters of beta gold and beta copper.

Trading Economics reports that analysts are forecasting gold prices to fall 11.7% from current levels and trade at $1,779.15 an ounce in a year, while the copper price will fall by about 4% and trade at $3.70 per pound.

About Centerra Gold Inc and its Metal Recovery Projects

Centerra operates the following mineral activities .

The Mount Milligan mine is not performing well, as evidenced by lower full-year 2022 earnings of $124.3 million compared to $165.2 million in 2021.

The facility is selling fewer ounces of gold and fewer pounds of copper and is suffering the effects of higher inflation in Canada, which is causing costly energy and labor procurement.

In Canada, the Bank of Canada expects annual inflation to come in at 4.3% as of March, hovering around 3% in the third quarter of this year and likely above the medium-term target of 2% for all of 2023. Elevated inflation will continue to impact the profitability of the mine operations.

The Mount Milligan mine produced 189,000 ounces of gold and 74 million pounds of copper in 2022 while forecasting lower 2023 gold production of 160,000 to 170,000 ounces and lower copper production of 60 million to 70 million pounds.

Mount Milligan will increase gold and copper production as a result of ongoing mine life optimization, but not until 2024.

Production costs were $767 per ounce of gold in 2022 and will be higher at $900 to $950 per ounce in 2023, while copper production costs totaled $1.70 per pound in 2022 versus a higher range of $1.90 to $2.15 per pound expected in 2023.

Total investments for the mine will increase to $65-$70 million in 2023, but this will impact profits and losses over multiple years, not over a single year.

In addition, Mount Milligan Mine is required by an agreement to sell 18.75% of its gold and copper production to Royal Gold, Inc. ( RGLD ) and 35% of its gold and copper production to Royal Gold, Inc. subsidiary RGLD Gold Inc.

Royal Gold, Inc. is a Denver, Colorado-based operator of precious metal streams, royalties and related mineral interests. Under the terms of the agreement, Royal Gold pays $435/oz. and pays 15% of the spot price per ton of copper shipped.

Centerra Gold uses a copper price of $3.55 per pound in its estimates of the approximate price it will realize by selling copper. This price is "blended" in the sense that it includes both copper hedging instruments and a market price of $3.25 per pound for the portion of copper production that is unhedged for 2023.

This mixed price is below the current copper price of $3.87 per pound and below analysts' 12-month price target of $3.70 per pound.

The Öksut mine in Türkiye , about 300 kilometers southeast of Ankara, was forced to halt gold activities at a facility a year ago after mercury was discovered in the facility's gold room, resulting in lower gold production of 54,691 ounces in 2022, down from 111,703 ounces.

Production costs fell 59% year-on-year to $21 million in 2022, but due to lower gold production. Mine operating income in 2022 decreased 43% year-on-year to $67.8 million. Capital expenditures in 2022 totaled $16 million, most of which was for property, plant and equipment acquisitions.

While waiting for the Öksüt facility to restart, the company continued mining, storage, crushing and stacking, which led to the following situation at the end of the year. As of December 31, 2022, there were approximately 200,000 ounces of gold to recover from the ore stockpile and heap leach pad.

However, due to the shutdown of the Öksut plant, the company has not released a production forecast for 2023.

The Molybdenum business unit includes the following assets. The Langeloth plant in Pennsylvania and two mines for the production of molybdenum. The mines are currently under care and maintenance. These are the Thompson Creek mine in Idaho and the company's 75% mineral interest in the Endako mine which is located in British Columbia, Canada.

The company is currently evaluating a possible re-opening of the Thompson Creek mine as molybdenum has a high price in the marketplace at the moment while the global outlook for the commodity is also encouraging.

In 2022, segment revenue increased 42% year-over-year to $276.1 million and cost of production increased 58% to $284.5 million. The segment suffered an operating loss of $13.6 million and free cash flow from operations was a deficit of $10.4 million.

The Goldfield project in Nevada is conducting drilling activities targeting an initial resource estimate to be released between June and August 2023 and thereafter Centerra should complete a feasibility study including an updated resource estimate.

Exploration and project development costs for the Goldfield project this year will be approximately $25-30 million as the company seeks to expand resources beyond known deposits and to test peripheral mine targets within the property.

The Kemess Project , which was an open-pit copper and gold mine in British Columbia, Canada, will be on care and maintenance in 2023 as well at a cost of $15-17 million.

In terms of the company's financial condition, the balance sheet was marked by a net cash position of $518.78 million as of December 31, 2022, which Centerra says is robust to meet its obligations and support all projected expenses for 2023.

The Stock Valuation

CGAU stock was trading at $6.79 per unit on the NYSE as of this writing for a market cap of $1.495 billion.

Shares are not trading low as they are above the 200-day simple moving average of $5.60, above the 100-day simple moving average of $6.23 and above the 50-day simple moving average of $6.61.

Shares are also above the middle point of $6.44 in the 52 Week Range of $3.77 to $9.11.

Investors should consider the possibility of selling some shares of CGAU given lower gold and copper prices and expected lower production of the metals but higher operating costs in 2023.

Under downward pressure from the aforementioned headwinds, shares could potentially trade much lower than current prices and as the 14-day Relative Strength Indicator of 47.70x suggests, there is room for lower market valuations.

Investors can draw similar conclusions for the CG:CA stock, which trades on the Toronto Stock Exchange.

CG:CA shares were trading at CA$9.25 per unit on the TSE as of this writing for a market cap of CA$2.04 billion.

Shares are not trading low as they are above the 200-day simple moving average of CA$7.51, above the 100-day simple moving average of CA$8.43 and above the 50-day simple moving average of CA$8.98.

Shares are also above the middle point of CA$8.45 in the 52 Week Range of CA$5.18 to CA$11.72. Also, the 14-day Relative Strength Indicator of 48.96x suggests there is room for shares to reach lower price levels.

The stock grants a forward dividend yield of 3.04% if the holding is traded on the NYSE, or of 3.06% if the holding is traded on the TSE.

Risk of a Sell Recommendation and Metals Prices Outlook

Selling shares of Centerra Gold Inc. carries the risk of missing out on growth opportunities if gold and/or copper prices rise, contrary to analysts’ estimates. This scenario could potentially materialize in the event of an economic recession, which would trigger robust demand for gold as a safe haven against the headwinds of the negative cycle. Or if China's economic recovery leads to strong copper consumption, as the Asian country is a top global consumer of red metal.

As for the economic recession, this should not hit until late 2023 and “will be of moderate severity”, Jay Bryson Wells Fargo Chief Economist said in a note last week Thursday, Yahoo Finance reported on April 28.

Until then rates will most likely be kept high as core inflation and the labor market should already have shown signs of easing and instead remain stubbornly tough to calm down or ease.

While employment is rising very rapidly, or at worst stabilizing in anticipation of greater sales for companies, the increase in prices is accelerating or, at worst, recovering .

So, a higher-yielding environment does not favor gold (as investing in physical metal does not generate income) but encourages demand for fixed-income securities such as bonds.

As for copper prices, the outlook suddenly turned bleak as demand for the base metal from China could suffer a severe setback as the Asian country's “manufacturing sector contracted unexpectedly in April”, Trading Economics says . As such, investors are concerned that instead of recovering from the lifting of the zero-tolerance policy on the Covid-19 virus, the Chinese economy is slowing down dramatically.

Conclusion

Investors should consider selling shares of Centerra Gold Inc., a Canadian gold and copper explorer and producer, as the stock is experiencing an extremely challenging environment.

Gold and copper prices are estimated to downtrend in 2023 due to a difficult context for the precious metal as a safe haven asset and an unexpected halt to the recovery in China, which bodes badly for copper demand.

Investors should be aware that this stock is highly exposed to fluctuations in commodity markets, which could amplify falls in metal prices.

The company is also facing some operational issues that will likely result in lower production and higher costs in 2023. These aspects, combined with expected headwinds in commodity prices, will not help generate better earnings than last year, potentially having a negative impact on the share price of the stock.

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