CA - NovaGold Resources Could Fall Sharply If Gold Turns Bearish

2023-03-22 00:10:02 ET

Summary

• The current surge in gold prices has no solid pillars while analysts are forecasting the yellow metal to trade lower this year.
• NovaGold Resources Inc. tracks gold, but the stock price has a high beta gold value, implying the potential for a major downside move if the yellow metal turns bearish.
• There are good reasons why investors should prefer the US currency and fixed-income securities to gold in what is currently a very risk-averse market environment.
• NG stock, which is moving forward with a project for future gold production in Alaska, could still see its stock price up, albeit slightly, but not at significantly higher levels than it is currently, while there is potential for significant downside thereafter.

Unfortunately for NovaGold Resources Inc. Shareholders, the Current Surge in Gold Prices Seem Short-Lived

The current gold rally does not appear to be well supported which greatly increases the risk involved in investing in certain assets such as NovaGold Resources Inc. ( NG ) as the market value of shares of this stock changes depending on the precious metal price development.

The chart below from Investing.com compares NovaGold Resources Inc. stock to Gold Futures - April 23 (GCJ2023), using the latter security as a benchmark for changes in the gold price.

The chart shows that over the past year (February 17, 2022, to March 17, 2023) shares of NovaGold Resources Inc. are down more than 20%, while gold futures are only marginally up over the period, at a rate of less than 4% growth.

The chart also shows that shares of NovaGold Resources Inc. follow the same direction when the price of gold moves, but when the precious metal is in a bearish mode, shareholders of this Canadian explorer and developer of gold mineral properties in the United States suffer quite a bit.

NovaGold Resources' Beta Gold Is the Kind that Matters

Despite the current rally, gold is unlikely to see an uptrend in 2023, meaning NovaGold Resources Inc. shareholders are also unlikely to see their positions appreciate.

Since NovaGold Resources Inc. appears to be quite volatile compared to changes in commodity prices, it could result in a major hit for shareholders if the yellow metal embarks on the path of a sustained decline in its market price.

The volatility of the stock compared to the price of gold (the beta gold) is measured by the following model, which is based on an assumed linear relationship between NovaGold Resources and Gold Futures - April 23 (GCJ2023). It determines how the stock's daily returns (the output or the dependent variable) move on average due to changes in the price of gold (the inputs or the independent variable).

Daily returns from February 17, 2022, to March 17, 2023, were included in the model for both securities after applying an arithmetic mean-based adjustment to the NovaGold Resources value distribution as the NYSE American operated fewer days than the COMEX market.

The coefficient of determination, called R², is 0.31, indicating that the chosen model is not fantastic from a reliability point of view but not a disaster either, the results can be used for making extrapolations.

The model suggests that in the short term, each percentage change in the price of gold will result in an average daily change in NovaGold Resources' share price of 1.7%.

As a portfolio could suffer a severe loss due to an overweight position in NovaGold Resources shares, based on the above model coupled with the following analyst gold price predictions, shareholders should mitigate the downside risk as follows. They may want to reduce their stake in NovaGold Resources if this transaction could give them a satisfactory return and use the money for other investments, possibly fixed-income securities or US dollar asset, as interest rates are likely to continue to rise to fight inflation.

Or investors might be interested in increasing their holdings in big banks, as these companies may now have an opportunity to attract more savings and deposits from some regional retail banks and strengthen their mainstay in the long term. Due to the crises at Silicon Valley Bank (SIVB) and Signature Bank ( SBNY ), the shares of the big banks should also be listed significantly lower, as the slump of almost 18% in the Dow Jones U.S. Banks Index (^DJUSBK), a benchmark for publicly traded stocks of US banks, suggests.

Trading Economics analysts are forecasting falling prices in both the short term and a year from now. In the meantime, there will be downsides and upsides, but these analysts expect the underlying movement in the gold price to be negative and estimate an 8.4% decline to $1,844.68 an ounce through March 31 and an 11.6% drop to $1,779.15 an ounce by the end of 2023, from levels as of this writing.

Why the Current Gold Price Rally Could Not Last

At the time of writing, gold traded through Gold Futures - April 23 (GCJ2023) - is experiencing an incredible price increase, reaching an all-time high of $2,012.65 per ounce, up nearly 2% from the previous close.

The rise in the value of the troy ounce of gold is a result of investors rushing to the precious metal to protect the value of their assets and relying on the nature of the precious metal as a safe haven against the exploding uncertainty caused by symptoms of a possible financial crisis.

Investors fear a collapse of the banking systems in both the US and Europe after the bankruptcies of Silicon Valley Bank and Signature Bank and the takeover of shaky competitor Credit Suisse Group AG ( CS ) by UBS Group AG ( UBS ) for 3 billion Swiss francs (around 3.35 billion US dollars) to defuse the progression of the crisis in the banking system.

But are investors right to fear such risks, or are they exaggerating in their assessments of near-term developments and perhaps underestimating reassurances from US and European politicians about the soundness of US and EU financial systems?

Should that be the case, i.e., if the markets are currently overreacting to the recent issues with US regional banks and the Swiss financial system, then the precious metal's ongoing rally is not on solid pillars and poses the risk of massive deflation, as the economy proves the contrary to investors.

Based on policymakers' assurances and some aspects characterizing the resilience of the European versus US banking system, the forthcoming evolution of the current situation should be able to show that the current fears of a deeper crisis in the financial system may be completely unfounded.

Therefore, those investors who increase their exposure to gold price changes could be making a big mistake when a large and sudden change in the current gold trend could leave them with bitter regrets.

The EU banking system is sound and more resilient than the US banking system, despite the current strong macroeconomic and geopolitical headwinds and possible contagion from US regional banks, as banks in Europe have fully implemented the Basel 3 agreements.

German chancellor Olaf Scholz last week addressed fears of a deeper crisis in the banking system, assuring markets that savings are safe at European banks and that Europe is not threatened by the SVB bankruptcy and the Credit Suisse financial crisis.

Instead, the US Treasury Department, the Federal Deposit Insurance Corporation ((FDIC)) and the Federal Reserve (Fed) noted how solid US banks are in terms of capital and liquidity. These monetary authorities also continue to work to find a suitable buyer to acquire 100% of Silicon Valley Bank, while the New York Community Bancorp ( NYCB ) seems interested in Signature Bank.

Banking systems are then strong enough to absorb a further rise in interest rates, which would increase the opportunity cost of holding gold instead of fixed-income assets.

Additionally, the annual inflation rate is still a long way off the 2% target set by the US Federal Reserve and European Central Bank ((ECB)), meaning central banks will need to keep increasing the cost of money to bring inflation back to target levels.

Last Thursday, the ECB raised interest rates by 0.5% to 3.5% and Wednesday, March 22, the Fed is expected to raise interest rates by 0.25% to 5%. So after the current near-term turmoil, investors will continue to weather the uncertainty by avoiding riskier US-listed securities, but focusing on high-yield securities such as fixed income.

About NovaGold Resources Inc.

NovaGold Resources Inc., headquartered in Vancouver, British Columbia, is a gold exploration company focused on developing the Donlin Gold Project in Alaska.

NovaGold Resources owns 50% of this mineral project which is an open pit gold deposit containing approximately 39 million ounces of gold in the measured and indicated mineral resource. These ounces are contained in approximately 541 million tons of mineral grading approximately 2.24 grams of gold per ton of ore.

NovaGold Resources is the owner of 19.5 million ounces of gold as the other 50% of the deposit belongs to Barrick Gold Corporation ( GOLD ).

To get to where it is today, the Donlin Gold Project has undergone several activities that have become necessary in recent years to reduce the project risk.

2022 activity consisted primarily of the largest drill program in more than 15 years in Alaska with 141 drill holes totaling 42,331 meters of exploration. According to the company, this drilling activity has produced very encouraging results with some excellent gold interceptions.

The next step for the Donlin Gold Project will be an updated feasibility study decision.

Once fully operational, this project is expected to be a source for long-term gold production from a friendly mining jurisdiction.

It's hard to say when Alaska's Donlin Gold Project is expected to start producing the precious metal, but production should be at 1.13 million ounces per year for a 25-30-year operation, according to miningdataonline .com.

The Company's Financial Ability to Fund the Project

The explorer says it has sufficient financial resources to develop its portion of the Donlin Gold Project (approximately 270.5 million tons of mineral) and to advance the project through an updated feasibility study.

The company states its balance sheet had approximately $126 million available in cash and term deposits as of November 30, 2022, which should be increased by $25 million from the payment due July 2023 by Newmont Corporation ( NEM ) since NovaGold Resources turned 50% ownership in British Columbia's Galore Creek project to Newmont.

NovaGold Resources could receive an additional $75 million, should Newmont make a construction decision at Galore Creek.

Looking ahead to 2023, NovaGold Resources expects to spend approximately $31 million. Of this, 55% is allocated for ongoing permitting activities in addition to project design and fieldwork at the Donlin Gold Project, while the remaining 45% is allocated for corporate and administrative costs, working capital and others.

Through 2023, NovaGold will continue to invest resources to fund a variety of activities that should prompt management to finally plan the future construction of the Donlin Gold Project. Until the decision is made, NovaGold Resources' share price will be largely exposed to the volatility of the gold market.

The Stock Valuation

Shares of NovaGold Resources Inc. are trading at $5.91 as of this writing giving it a market cap of $1.93 billion.

The stock has a 52-week range of $4.06 to $8.36, so the stock price is currently below the median of $6.21, but that does not mean investors should not soften their positions.

The shares are also below the 50-day simple moving average, equal to the 100-day simple moving average, but well above the 200-day simple moving average.

Supported by the recent rebound in gold prices, NovaGold's share price appears to be projected to higher levels than current ones, but for the reasons set out in this analysis, share prices should not be given sufficient time to rise significantly above their current levels.

Indeed, the recent positive impact on stock prices from gold's resurgence as a hedge against fears of a domino effect from the banking crisis may not last.

The monetary authorities of Western economies, bolstered by the experience of the 2008 financial crisis, believe they are much more reactive in nipping in the bud a potential problem for the banking system that could threaten the financing of the economy.

It also means central banks can continue to fight inflation with higher interest rates, which certainly will not fuel demand for gold as a hedge versus uncertainty since its first rivals, the US dollar and interest-bearing fixed income will attract risk-averse investors.

A lower gold price could potentially impact NovaGold Resources' shares in a very negative manner, pushing these to significantly lower levels than they currently are, as this gold explorer's market value is also characterized by high volatility compared to changes in the price of gold.

Attempting to gauge whether the stock price is cheaper or more expensive than its peers is almost impossible as the company is not generating any revenue as it is still in the permitting stage for its future gold production in Alaska.

However, it is possible to assign a value to its equity and based on that and the share price, NovaGold Resources reports a 12-month price/book ratio of 64.61x, which is well above the industry median of 1.65x and the stock 5-year average of 26.18x.

NovaGold Resources Inc. (NG:CA) is also traded on the Toronto Stock Exchange with shares trading at Canadian dollars 8.07 per unit giving it a market capitalization of CA$2.695 billion. The stock has a 52-week range of CA$ 5.35 to CA$ 10.53. The stock has a 50-day moving average of CA$ 8.24 and a 200-day moving average of CA$ 7.12.

Conclusion

Investors should consider selling some shares of NovaGold Resources as the stock price could follow a probable drop in the price of gold soon.

Gold has been rising for the past few days on fears of a financial system collapse following some bank failures in America.

However, these fears, which are causing the positive impact of gold prices on NovaGold, do not appear to be very well founded to stimulate an ongoing bull market.

With gold likely to trend lower in 2023 as analysts believe, NovaGold Resources could fall sharply due to high volatility relative to the yellow metal.

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