Gold juniors’ Q1’18 fundamentals
The junior gold miners have largely been shunned over the past year or so, condemned to listlessly drift near lows. Their stock prices have suffered serious collateral damage from stubbornly-bearish gold sentiment. But they are faring much better under the hood than their battered visages suggest, with their latest quarterly results revealing strong fundamentals. Juniors are ready to soar when gold sentiment turns.
Four times a year publicly-traded companies release treasure troves of valuable information in the form of quarterly reports. Companies trading in the States are required to file 10-Qs with the US Securities and Exchange Commission by 45 calendar days after quarter-ends. Canadian companies have similar requirements. In other countries with half-year reporting, many companies still partially report quarterly.
The definitive list of elite “junior” gold stocks to analyze comes from the world’s most-popular junior-gold-stock investment vehicle. This week the GDXJ VanEck Vectors Junior Gold Miners ETF reported $4.6b in net assets. Among all gold-stock ETFs, that was second only to GDX’s $7.6b. That is GDXJ’s big-brother ETF that includes larger major gold miners. GDXJ’s popularity testifies to the great allure of juniors.
Unfortunately this fame created serious problems for GDXJ over the past couple years, resulting in a major mission change. This ETF is quite literally the victim of its own success. GDXJ grew so large in the first half of 2016 as gold stocks soared in a massive upleg that it risked running afoul of Canadian securities laws. And most of the world’s smaller gold miners and explorers trade on Canadian stock exchanges.
Since Canada is the center of the junior-gold universe, any ETF seeking to own this sector will have to be heavily invested there.
Since Canada is the center of the junior-gold universe, any ETF seeking to own this sector will have to be heavily invested there. But once any investor including an ETF buys up a 20%+ stake in any Canadian stock, it is legally deemed to be a takeover offer that must be extended to all shareholders! As capital flooded into GDXJ in 2016 to gain junior-gold exposure, its ownership in smaller components soared near 20%.
Obviously hundreds of thousands of investors buying shares in an ETF have no intention of taking over gold-mining companies, no matter how big their collective stakes. That’s a totally-different scenario than a single corporate investor buying 20%+. GDXJ’s managers should’ve lobbied Canadian regulators and lawmakers to exempt ETFs from that 20% takeover rule. But instead they chose an inferior, easier fix.
Since GDXJ’s issuer controls the junior-gold-stock index underlying its ETF, it simply chose to unilaterally redefine what junior gold miners are. It rejiggered its index to fill GDXJ’s ranks with larger intermediate gold miners, while greatly demoting true smaller junior gold miners in terms of their ETF weightings. This controversial move defying many decades of convention was done stealthily behind the scenes to avoid outrage.
There’s no formal definition of a junior gold miner, which gives cover to GDXJ’s managers pushing the limits. Major gold miners are generally those that produce over 1m ounces of gold annually. For decades juniors were considered to be sub-200k-ounce producers. So 300k ounces per year is a very-generous threshold. Anything between 300k to 1m ounces annually is in the mid-tier realm, where GDXJ now traffics.
That high 300k-ounce-per-year junior cutoff translates into 75k ounces per quarter. Following the end of the gold miners’ Q1’18 earnings season in mid-May, I dug into the top 34 GDXJ components’ results. That’s just an arbitrary number that fits neatly into the tables below. Although GDXJ included a staggering 73 component stocks in mid-May, the top 34 accounted for a commanding 80.1% of its total weighting.
Out of these top 34 GDXJ companies, only 5 primary gold miners met that sub-75k-ounces-per-quarter qualification to be a junior gold miner! Their quarterly production is highlighted in blue below, and they collectively accounted for just 10.3% of GDXJ’s total weighting. But even that is really overstated, as 3 of these are long-time traditional major silver miners that are increasingly diversifying into gold in recent years.
GDXJ is inarguably now a pure mid-tier gold-miner ETF. That would be great if GDXJ was advertised as such. But it’s very misleading if investors still believe this dominant “Junior Gold Miners ETF” still gives exposure to junior gold miners. I suspect the vast majority of GDXJ shareholders have no idea just how radically its holdings have changed since early 2016, and how much it has strayed from its original mission.
I’ve been doing these deep quarterly dives into GDXJ’s top components for years now. In Q1’18, fully 30 of the top 34 GDXJ components were also GDX components! These ETFs are separate, a “Gold Miners ETF” and a “Junior Gold Miners ETF”. So there’s no reason for them to own many of the same companies. In the tables below I highlighted the symbols of rare GDXJ components not also in GDX in yellow.
These 30 GDX components accounted for 75.0% of GDXJ’s total weighting, not just its top 34. They also represented 31.4% of GDX’s total weighting. So 3/4ths of this “Junior Gold Miners ETF” is made up of nearly a third of the major “Gold Miners ETF”! These GDXJ components in GDX start at the 12th-highest weighting in that latter larger ETF and extend down to 45th. Do investors know GDXJ is mostly GDX gold stocks?
Fully 11 of GDXJ’s top 17 components weren’t even in this ETF a year ago in Q1’17. They alone now account for 34.6% of its total weighting. 16 of the top 34 are new, or 43.4% of the total. In the tables below, I highlighted the symbols of companies that weren’t in GDXJ a year ago in light blue. GDXJ has changed radically, and analyzing its top components’ Q1’18 results largely devoid of real juniors is frustrating.
Nevertheless, GDXJ remains the leading “junior-gold” benchmark. So every quarter I wade through tons of data from its top components’ 10-Qs or 10-Ks, and dump it into a big spreadsheet for analysis. The highlights made it into these tables. Most of these top 34 GDXJ gold miners trade in the US and Canada where comprehensive quarterly reporting is required by regulators, but some trade in Australia and the UK.
There regulators only mandate companies to report in half-year increments. Fortunately many of those gold miners still do tend to issue production reports without financial statements each quarter. But there are wide variations in reporting styles, data presented, and release timing. Blank fields in these tables mean a company hadn’t reported that data for Q1’18 as of this Wednesday, after Q1 earnings season’s end.
The first couple columns of these tables show each GDXJ component’s symbol and weighting within this ETF as of mid-May. While the majority of these stocks trade on US exchanges, many symbols are listings from companies’ primary foreign stock exchanges. That’s followed by each gold miner’s Q1’18 production in ounces, which is mostly in pure-gold terms. That excludes byproduct metals often present in gold ore.
These are mostly silver and base metals like copper, which are valuable. They are sold to offset some of the considerable costs of gold mining, lowering per-ounce costs and thus raising overall profitability. In cases where companies didn’t separate out gold and lumped all production into gold-equivalent ounces, these GEOs are included instead. Then production’s absolute year-over-year change from Q1’17 is shown.
Next comes gold miners’ most-important fundamental data for investors, cash costs and all-in sustaining costs per ounce mined. The latter directly drives profitability which ultimately determines stock prices. These key costs are also followed by YoY changes. Last but not least the annual changes are shown in operating cash flows generated, hard GAAP earnings, sales, and cash on hand with a couple exceptions.
Percentage changes aren’t relevant or meaningful if data shifted from positive to negative or vice versa, or if derived from two negative numbers. So in those cases I included raw underlying data rather than weird or misleading percentage changes. This whole dataset together offers a fantastic high-level read on how the mid-tier gold miners are faring fundamentally as an industry. And that was really well in Q1’18!
Once again the light-blue-highlighted symbols are new top-34 GDXJ components that weren’t included a year ago in Q1’17. And the few yellow-highlighted symbols are the only stocks that were not also GDX components in mid-May. Despite still being advertised as a “Junior Gold Miners ETF”, in reality GDXJ is now a mid-tier gold miners ETF. That’s fine if investors realize this, but misleading if they’re unaware.
Having such massive overlap between GDXJ and GDX is a huge lost opportunity for VanEck. It owns and manages GDX, GDXJ, and the MVIS indexing company that decides exactly which gold stocks are included in each. With one company in total control, there’s no need for any overlap in the underlying companies of what should be two very-different gold-stock ETFs. Inclusion ought to be mutually-exclusive.
VanEck could greatly increase the utility of its gold-stock ETFs and thus their ultimate success by starting with one big combined list of the world’s better gold miners. Then it could take the top 20 or 25 in terms of annual gold production and assign them to GDX. Based on Q1’18 production, that would run down near 129k to 89k ounces per quarter. Then the next-largest 30 or 40 gold miners could be assigned to GDXJ.
Getting smaller gold miners back into GDXJ would be a huge boon for the junior-gold-mining industry. Most investors naturally assume this “Junior Gold Miners ETF” owns junior gold miners, which is where they are trying to allocate their capital. But since most of GDXJ’s funds are instead diverted into much-larger mid-tiers and even some majors, the juniors are effectively being starved of capital intended for them.
That’s one of the big reasons smaller gold miners’ stock prices are so darned low. They aren’t getting enough capital inflows from gold-stock-ETF investing. So their share prices aren’t bid higher. They rely on issuing shares to finance their exploration projects and mine builds. But when their stock prices are down in the dumps, that is heavily dilutive. So GDXJ is strangling the very industry its investors want to own!
Back to Q1’18 results, production is the best place to start since that’s the heart of the whole gold-mining industry. These top 34 GDXJ gold miners collectively produced 3986k ounces of gold last quarter, which rocketed 90.2% higher YoY! But because of GDXJ’s huge component changes over the past year, this comparison is meaningless. Thankfully Q1’18 should be the last quarter straddling this epic discontinuity.
It was the second quarter of 2017 when GDXJ’s constituency list was radically altered to look much more like today’s. Many smaller gold-mining stocks were demoted or booted to make way for the parade of much-larger imports from GDX. So when this current quarter’s results are released this summer, GDXJ’s year-over-year comparisons should be back on apples-to-apples footing. That will be nice after a year of turmoil.
For all GDXJ’s faults, it does still offer investors exposure to much-smaller gold miners. Last week I did a similar analysis with the top GDX components’ Q1’18 results. Their quarterly production averaged 279k ounces, well into major territory above 1m annually. But the top 34 GDXJ miners’ comparable number was 121k ounces, which is about 57% smaller. This is solidly into the mid-tier realm, a different focus than GDX.
This current list of GDXJ’s top miners are actually growing their gold production nicely, with an average gain of 7.7% YoY. That is about double the 3.8% of GDX’s top miners in Q1. It’s much easier to grow off smaller bases. Generally the smaller the gold miners in market-capitalization and production terms, and the faster they are growing, the more stock-price appreciation potential they have when sentiment is favorable.
With today’s set of top-34 GDXJ gold miners achieving such impressive production growth, their costs per ounce should’ve declined proportionally. Higher production yields more gold to spread mining’s big fixed costs across. And lower per-ounce costs naturally lead to higher profits. So production growth is highly sought after by gold-stock investors, with companies able to achieve it commanding premium prices.
There are two major ways to measure gold-mining costs, classic cash costs per ounce and the superior all-in sustaining costs per ounce. Both are useful metrics. Cash costs are the acid test of gold-miner survivability in lower-gold-price environments, revealing the worst-case gold levels necessary to keep the mines running. All-in sustaining costs show where gold needs to trade to maintain current mining tempos indefinitely.
Cash costs naturally encompass all cash expenses necessary to produce each ounce of gold, including all direct production costs, mine-level administration, smelting, refining, transport, regulatory, royalty, and tax expenses. In Q1’18, these top 34 GDXJ-component gold miners that reported cash costs averaged $692 per ounce. That surged a sharp 7.0% YoY, not what you’d expect given the higher gold production.
But these cash costs were skewed way higher by major South African gold miners that should never have been included in GDXJ. They are all way too big, and that country is suffering a nightmare scenario with an openly-racist government trying to steal all ownership away from anyone without black skin. So all the once-proud South African gold miners have serious problems on multiple fronts that look insurmountable.
Due to technical challenges of very-deep mining and endless labor unrest, production is sliding at the big South African miners.
Due to technical challenges of very-deep mining and endless labor unrest, production is sliding at the big South African miners. That helped catapult cash costs at Sibanye Gold and Harmony Gold to truly-crazy levels of $1155 and $1215 per ounce in Q1! Excluding just these two outliers, the rest of these top 34 GDXJ miners had cash costs averaging $650. That’s up just 0.5% YoY and better than top GDX miners’ $667.
Way more important than cash costs are the far-superior all-in sustaining costs. They were introduced by the World Gold Council in June 2013 to give investors a much-better understanding of what it really costs to maintain gold mines as ongoing concerns. AISCs include all direct cash costs, but then add on everything else that is necessary to maintain and replenish operations at current gold-production levels.
These additional expenses include exploration for new gold to mine to replace depleting deposits, mine-development and construction expenses, remediation, and mine reclamation. They also include the corporate-level administration expenses necessary to oversee gold mines. All-in sustaining costs are the most-important gold-mining cost metric by far for investors, revealing gold miners’ true operating profitability.
These top 34 GDXJ gold miners reporting AISCs saw their average slip 0.1% lower YoY to $923 per ounce in Q1’18. These dead-flat levels are very interesting considering the radically-different GDXJ component list over the past year. That also compares favorably with the GDX majors which have much-better economies of scale with more gold mines. Their AISCs averaged $884 in Q1, only 4.2% lower.
And again those big South African gold miners skewed average GDXJ AISCs higher. While Harmony didn’t report AISCs, Sibanye’s surged to a scary $1336 per ounce! Cut that out, and the rest of these top 34 GDXJ gold miners’ average AISCs retreat to $904. Gold miners generally have higher costs in Q1s too, as that’s when mine managers often choose to process lower-grade ores which retards gold production.
Ores within gold deposits were certainly not created equal. Miners have to dig through lower-grade ores on the way to higher-grade stuff. Regardless of how much gold in the rock processed, the throughput of mines is fixed. Their mills can only process the same tonnages of rock quarter after quarter. So when lower-grade ore is sequenced, less gold is produced. The big fixed costs of mining are spread across fewer ounces.
Gold miners game their ore grades, tending to collectively have the lowest production and thus highest costs in Q1s and the opposite in Q4s. These top GDXJ components’ total gold production fell 4.9% QoQ from Q4’17! I suspect the reason mine managers choose to process lower-grade ores early on in new years and higher-grade ores later is to maximize their year-end stock-price appreciation and hence bonuses!
The mid-tier gold miners’ still-low costs last quarter prove they are faring far better fundamentally today than their low stock prices imply. All-in sustaining costs are effectively this industry’s breakeven level. As long as gold stays above $923 per ounce, it remains profitable to mine. At Q1’18’s average gold price of $1329, these top GDXJ gold miners were still actually earning big average profits of $406 per ounce.
That’s up an impressive 37.2% YoY, as the top 34 GDXJ gold miners in Q1’17 had average AISCs of $924 in a lower-gold-price environment averaging $1220. Given such major earnings growth, investment capital should be flooding into the mid-tier gold miners. Yet inexplicably GDXJ’s average share price of $32.82 in Q1’18 was 12.4% lower than Q1’17’s $37.46! Today’s gold-stock levels are fundamentally-absurd.
Gold miners offer such compelling investment opportunities because of their inherent profits leverage to gold. Gold-mining costs are largely fixed during mine-planning stages, when engineers and geologists decide which ore to mine, how to dig to it, and how to process it. The actual mining generally requires the same levels of infrastructure, equipment, and employees quarter after quarter regardless of gold prices.
With gold-mining costs essentially fixed, higher or lower gold prices flow directly through to the bottom line in amplified fashion. This really happened in GDXJ over the past year despite its radical changes in composition. An 8.9% gold rally in quarterly-average terms catapulted operating profits 37.2% higher, or 4.2x. That’s even better than the typical leverage of gold-mining profits to gold prices of several times or so.
The mid-tier gold miners’ stocks can’t trade as if their profits don’t matter forever, so an enormous mean-reversion rally higher is inevitable sooner or later. And that assumes gold prices merely hold steady, which is unlikely. Radical gold underinvestment reigns today after years of extreme central-bank easing. As major central banks start unwinding their epic QE, stock markets will sell off and investors will return to gold.
The impact of higher gold prices on mid-tier-gold-miner profitability is easy to model. Assuming flat all-in sustaining costs at Q1’18’s $923 per ounce, 10%, 20%, and 30% gold rallies from this week’s levels would lead to collective gold-mining profits surging 23%, 55%, and 87%! And another 30% gold upleg isn’t a stretch at all. In the first half of 2016 alone after the previous stock-market correction, gold soared 29.9%.
GDXJ skyrocketed 202.5% higher in 7.0 months in largely that same span! Gold-mining profits and thus gold-stock prices surge dramatically when gold is powering higher. Years of neglect from investors have forced the gold miners to get lean and efficient, which will really amplify their fundamental upside during the next major gold upleg. The investors and speculators who buy in early and cheap could earn fortunes.
Given the radical changes in GDXJ’s composition over the past year, normal year-over-year comparisons in key financial results simply aren’t meaningful. Again the massive rejiggering of the index underlying GDXJ didn’t happen until Q2’17, so Q1’18 is the last quarter before results finally grow comparable. But in the meantime, here’s the apples-to-oranges reads on the top 34 GDXJ components’ key financial results.
Cash flows generated from operations soared 134.0% YoY to $1367m. As long as OCFs stay massively positive, the gold mines are generating more cash than they cost to run. That gives the gold miners the capital necessary to expand existing operations and buy new deposits and mines. It is shocking that an industry so cash-flow-positive is plagued by such ridiculously-irrational bearish sentiment, that can’t last.
On the hard-profits front under the Generally Accepted Accounting Principles required by the SEC, these top 34 GDXJ gold miners earned $161m in Q1’18. That was up 42.3% YoY, from a very-different list of top GDXJ components. That would look far better if it wasn’t for Yamana Gold, which alone lost $161m in Q1 from a big non-cash impairment charge on a smaller gold miner it bought. That was the only big GDXJ loss.
Revenues surged 80.4% YoY to $4320m, and cash on balance sheets climbed 25.2% to $6390m. There isn’t much analysis to do with such radically-different GDXJ constituent lists, so I can’t wait for Q2’18 when comparable results return. But the mid-tier gold miners were faring quite well fundamentally last quarter despite their silly bargain-basement stock prices. This anomaly has to be resolved to the upside.
The mid-tier gold miners’ Q1’18 results proved again that gold stocks’ vexing consolidation since early 2017 isn’t the result of operational struggles, but merely bearish psychology. That will soon shift as these wildly-overvalued stock markets inevitably roll over, leading to surging gold investment demand. These elite mid-tier gold miners’ stocks are a coiled spring overdue to soar dramatically, with vast upside potential.
While GDXJ should certainly no longer be advertised as a “Junior Gold Miners ETF”, it offers exposure to some of the best mid-tier gold miners on the planet. It’s growing on me, I like this new GDXJ way better than GDX. That being said, GDXJ is still burdened by overdiversification and way too many gold miners with inferior fundamentals that shouldn’t be in there. They include those struggling big South African miners.
So the best way to play the gold miners’ coming massive mean-reversion bull is in individual stocks with superior fundamentals. Their gains will ultimately trounce the major ETFs like GDXJ and GDX. There’s no doubt carefully-handpicked portfolios of elite gold and silver miners will generate much-greater wealth creation. GDXJ’s component list is a great starting point, but pruning it way down offers far-bigger upside.
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The bottom line is the mid-tier gold miners now dominating GDXJ enjoyed strong fundamentals in their recently-reported Q1 results. While GDXJ’s radical composition changes since last year muddy annual comparisons, today’s components mined lots more gold at dead-flat costs. These miners continued to earn fat operating profits while generating strong cash flows. Sooner or later stock prices must reflect fundamentals.
As gold itself continues mean reverting higher, these mid-tier gold miners will see their profits soar due to their big inherent leverage to gold. GDXJ now offers excellent exposure to mid-tier gold miners, which will see gains well outpacing the majors. All it will take to ignite gold stocks’ overdue mean-reversion rally is gold investment demand returning. The resulting higher gold prices will attract investors back to gold miners.
Adam Hamilton, CPA
May 25, 2018
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