Adam Hamilton: Gold Miners' Q4'17 Fundamentals

The gold miners' stocks remain deeply out of favor, trading at prices seen when gold was half or even a quarter of current levels. So many traders assume this small contrarian sector must be really struggling fundamentally. But nothing could be farther from the truth! The major gold miners' recently-released Q4'17 results prove they are thriving. Their languishing stock prices are the result of irrational herd sentiment.

Four times a year publicly-traded companies release treasure troves of valuable information in the form of quarterly reports. Required by securities regulators, these quarterly results are exceedingly important for investors and speculators. They dispel all the sentimental distortions surrounding prevailing stock-price levels, revealing the underlying hard fundamental realities. They serve to re-anchor perceptions.

Normally quarterlies are due 45 calendar days after quarter-ends, in the form of 10-Qs required by the SEC for American companies. But after the final quarter of fiscal years, which are calendar years for most gold miners, that deadline extends out up to 90 days depending on company size. The 10-K annual reports required once a year are bigger, more complex, and need fully-audited numbers unlike 10-Qs.

So it takes companies more time to prepare full-year financials and then get them audited by CPAs right in the heart of their busy season. The additional delay in releasing Q4 results is certainly frustrating, as that data is getting stale approaching the end of Q1. Compounding the irritation, some gold miners don't actually break out Q4 separately. Instead they only report full-year results, lumping in and obscuring Q4.

I always wonder what gold miners that don't report full Q4 results are trying to hide. Some Q4 numbers can be inferred by comparing full-year results to the prior three quarterlies, but others aren't knowable if not specifically disclosed. While most gold miners report their Q4 and/or full-year results by 7 to 9 weeks after year-ends, some drag their feet and push that 13-week limit. That's very disrespectful to investors.

All this unfortunately makes Q4 results the hardest to analyze out of all quarterlies. But delving into them is still well worth the challenge. There's no better fundamental data available to gold-stock investors and speculators than quarterly results, so they can't be ignored. They offer a very valuable true snapshot of what's really going on, shattering all the misconceptions bred by the ever-shifting winds of sentiment.

The definitive list of major gold-mining stocks to analyze comes from the world's most-popular gold-stock investment vehicle, the GDX VanEck Vectors Gold Miners ETF. Its composition and performance are similar to the benchmark HUI gold-stock index. GDX utterly dominates this sector, with no meaningful competition. This week GDX's net assets are 24.4x larger than the next-biggest 1x-long major-gold-miners ETF!

Being included in GDX is the gold standard for gold miners, requiring deep analysis and vetting by elite analysts. And due to ETF investing eclipsing individual-stock investing, major-ETF inclusion is one of the most-important considerations for picking great gold stocks. As the vast pools of fund capital flow into leading ETFs, these ETFs in turn buy shares in their underlying companies bidding their stock prices higher.

This week GDX included a whopping 51 component "Gold Miners". That term is used somewhat loosely, as this ETF also contains major silver miners, a silver streamer, and gold royalty companies. Still, all the world's major gold miners are GDX components. Due to time constraints I limited my deep individual-company research to this ETF's top 34 stocks, an arbitrary number that fits neatly into the tables below.

Collectively GDX's 34 largest components now account for 90.5% of its total weighting, a commanding sample. GDX's stocks include major foreign gold miners trading in Australia, Canada, and the UK. Some countries' regulations require financial reporting in half-year increments instead of quarterly, which limits local gold miners' Q4 data. But some foreign companies still choose to publish limited quarterly results.

The importance of these top-GDX-component gold miners can't be overstated. In Q4'17 they collectively produced over 10.3m ounces of gold, or 321.5 metric tons. The World Gold Council's recently-released Q4 Gold Demand Trends report, the definitive source on worldwide supply-and-demand fundamentals, pegged total global mine production at 833.1t in Q4. GDX's top 34 miners alone accounted for nearly 4/10ths!

Every quarter I wade through a ton of data from these elite gold miners' 10-Qs or 10-Ks, and dump it into a big spreadsheet for analysis. The highlights made it into these tables. Blank fields mean a company did not report that data for Q4'17 as of this Wednesday. Naturally companies always try to present their quarterly results in the best-possible light, which leads to wide variations in reporting styles and data offered.

In these tables the first couple columns show each GDX component's symbol and weighting within this ETF as of this week. While most of these gold stocks trade in the States, not all of them do. So if you can't find one of these symbols, it's a listing from a company's primary foreign stock exchange. That's followed by each company's Q4'17 gold production in ounces, which is mostly reported in pure-gold terms.

Many gold miners also produce byproduct metals like silver and copper. These are valuable, as they are sold to offset some of the considerable costs of gold mining. Some companies report their quarterly gold production including silver, a construct called gold-equivalent ounces. I only included GEOs if no pure-gold numbers were reported. That's followed by production's absolute year-over-year change from Q4'16.

Next comes the most-important fundamental data for gold miners, cash costs and all-in sustaining costs per ounce mined. The latter determines their profitability and hence ultimately stock prices. Those are also followed by YoY changes. Finally the YoY changes in cash flows generated from operations, GAAP profits, revenues, and cash on balance sheets are listed. There are a couple exceptions to these YoY changes.

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 numbers instead of weird or misleading percentage changes. This whole dataset offers a fantastic high-level read on how the major gold miners are faring today as an industry. And contrary to their low stock prices, they are thriving!

After spending days digesting these elite gold miners' latest quarterly reports, it's fully apparent their vexing consolidation over the past year or so isn't fundamentally-righteous at all! Traders have mostly abandoned this sector because the allure of the levitating general stock markets has eclipsed gold. That has left gold stocks exceedingly undervalued, truly the best fundamental bargains out there in all the stock markets!

Since gold miners are in the business of wresting gold from the bowels of the Earth, production is the best place to start. The 10,337k ounces of gold collectively produced last quarter by these elite major gold miners actually fell a sizable 1.7% YoY! Interestingly that's right in line with industry trends per the World Gold Council, as overall world gold mine production also retreated that same 1.7% YoY in Q4'17.

These biggest and best gold miners on the planet certainly had every incentive to grow their gold production. The quarterly average gold price surged 4.8% YoY in Q4'17, really boosting profitability. Of course the more gold any miner can produce, the more opportunities it has to expand thanks to higher cash flows. Investors often punish flagging production too, so the major gold miners really hate reporting it.

Most investors won't bother studying long and detailed 10-Qs, 10-Ks, or the accompanying management discussions and analyses. So gold miners often issue short press releases summarizing some of their quarterly results. These sometimes intentionally mask production declines by excluding year-ago production, looking at quarter-on-quarter performance instead of year-over-year, or only comparing results to guidance.

As a professional speculator, investor, and newsletter writer for nearly two decades now, I spend a huge amount of time analyzing quarterly results. And I remain a CPA after my previous late-1990s gig auditing mining companies for a Big Six firm. Yet even with this exceptional experience and knowledge, I'm still surprised how deeply I have to dig for some key results miners bury and hide in hundred-plus-page-long SEC filings.

So believe me, major gold miners don't shout out shrinking gold production from the rooftops. Yet of the 32 of these top-34 GDX gold miners reporting Q4 production as of the middle of this week, fully half saw declines. That was even with four different gold miners climbing into GDX's top 34 components over the past year, which are highlighted in blue above. The average production decline was a serious 9.5% YoY!

Gold deposits economically viable to mine are very rare in the natural world, and the low-hanging fruit has largely been harvested. It is growing ever more expensive to explore for gold, in far-less-hospitable places. Then even after new deposits are discovered, it takes up to a decade to jump through all the Draconian regulatory hoops necessary to secure permitting. And only then can mine construction finally start.

That takes additional years and hundreds of millions if not billions of dollars per gold mine. But because gold-mining stocks have been deeply out of favor most of the time since 2013, capital has been heavily constrained. When banks are bearish on gold prices, they aren't willing to lend to gold miners except with onerous terms. And when investors aren't buying gold stocks, issuing new shares low is heavily dilutive.

The large gold miners used to rely heavily on the smaller junior gold miners to explore and replenish the gold-production pipeline. But juniors have been devastated since 2013, starved of capital. Not only are investors completely uninterested with general stock markets levitating, but the rise of ETFs has funneled most investment inflows into a handful of larger-market-cap juniors while the rest see little meaningful buying.

So even the world's biggest and best gold miners are struggling to grow production. While that isn't great for those individual miners, it's super-bullish for gold. The less gold mined, the more gold supply will fail to keep pace with demand. That will result in higher gold prices, making gold mining more profitable in the future. Some analysts even think peak gold has been reached, that mine production will decline indefinitely.

There are strong fundamental arguments in favor of peak-gold theories. But regardless of where overall global gold production heads in coming years, the major gold miners able to grow their own production will fare the best. They'll attract in relatively-more investor capital, bidding their stocks to premium prices compared to peers who can't grow production. Stock picking is more important than ever in this ETF world!

But despite slowing gold production, these top-34 GDX-component gold miners remained quite strong fundamentally in Q4! Their viability and profitability are measured by the differences between prevailing gold prices and what it costs to produce that gold. Despite traders' erroneous perception gold stocks are doomed, rising gold prices and falling mining costs are making the major gold miners much more profitable.

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 Q4'17, these top-34 GDX-component gold miners that reported cash costs averaged just $600 per ounce. That dropped a sizable 4.4% YoY, showing serious gold-miner discipline controlling costs.

Today the gold miners' stocks are trading at crazy-low prices implying their survivability is in jeopardy. This week the flagship HUI gold-stock index was languishing near 174, despite $1325 gold. The first time the HUI hit 175 in August 2003, gold was only in the $350s! Gold stocks are radically undervalued today by every metric. And they collectively face zero threat of bankruptcies unless gold plummets under $600.

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. AISC 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.

In Q4'17, these top-34 GDX-component gold miners reporting AISC averaged just $858 per ounce. That was down a significant 2.0% YoY, extending a welcome declining trend. In 2017's four quarters, these major gold miners' average AISCs ran $878, $867, $868, and $858. The elite gold miners are getting more efficient at producing their metal, which is definitely impressive considering their collective lower production.

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. So the more gold mined, the more ounces to spread those big fixed costs across. Thus production and AISCs are usually negatively correlated.

The major gold miners have to manage costs exceptionally well to drive AISCs lower while production is also slowing. This argues against the popular complaint that gold miners' managements are doing poor jobs. Because gold-stock prices are so darned low, traders again assume the miners must be plagued with serious fundamental problems. But it's relentlessly-bearish herd sentiment suppressing gold-stock prices.

These top-34 GDX gold miners are actually earning strong operating profits today. Q4'17's average gold price ran near $1276, again up 4.8% YoY. That remains far above last quarter's low average all-in sustaining costs among these major gold miners of $858 per ounce. Thus industry profit margins are way up at $418 per ounce. Most other industries would sell their souls to earn fat profit margins at this 33% level!

A year earlier in Q4'16, the top-34 GDX gold miners reported average AISCs of $875 in a quarter where gold averaged under $1218. That made for $343 per ounce in operating profits. So in Q4'17, the major gold miners' earnings soared 22.1% YoY to $418 on that mere 4.8% gold rally! Gold miners make such compelling investment opportunities because of their inherent profits leverage to gold, multiplying its gains.

But this strong profitability sure isn't being reflected in gold-stock prices. In Q4'17 the HUI averaged just 189.4, actually 1.5% lower than Q4'16's 192.3! The vast fundamental disconnect in gold-stock prices today is absurd, and can't last forever. Sooner or later investors will rush into the left-for-dead gold stocks to bid their prices far higher. This bearish-sentiment-driven anomaly has grown more extreme in 2018.

Since gold-mining costs don't change much quarter-to-quarter regardless of prevailing gold prices, it's reasonable to assume the top GDX miners' AISCs will largely hold steady in the current Q1'18. And it's been a strong quarter for gold so far, with it averaging over $1329 quarter-to-date. If the major gold miners' AISCs hold near $858, that implies their operating profits are now running way up near $471 per ounce.

That would make for a massive 12.7% QoQ jump in earnings for the major gold miners in this current quarter! Yet so far in Q1 the HUI is averaging just 187.1, worse than both Q4'17 and Q4'16 when gold prices were considerably lower and mining costs were higher. The gold miners' stocks can't trade as if their profits don't matter forever, so an enormous mean-reversion rally higher is inevitable sometime soon.

And that assumes gold prices merely hold steady, which is unlikely. After years of relentlessly-levitating stock markets thanks to extreme central-bank easing, radical gold underinvestment reigns today. As the wildly-overvalued stock markets inescapably sell off on unprecedented central-bank tightening this year, gold investment will really return to favor. That portends super-bullish-for-miners higher gold prices ahead.

The impact of higher gold prices on major-gold-miner profitability is easy to model. Assuming flat all-in sustaining costs at Q4'17's $858 per ounce, 10%, 20%, and 30% gold rallies from this week's levels would lead to collective gold-mining profits surging 43%, 75%, and 107%! 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%.

GDX skyrocketed 151.2% higher in 6.4 months in essentially 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 amplify their fundamental upside during the next major gold upleg. The investors and speculators who buy in early and cheap could earn fortunes.

While all-in sustaining costs are the single-most-important fundamental measure that investors need to keep an eye on, other metrics offer peripheral reads on the major gold miners' fundamental health. The more important ones include cash flows generated from operations, actual accounting profits, revenues, and cash on hand. They generally corroborated AISCs in Q4'17, proving the gold miners are faring really well.

These top-34 GDX-component gold miners collectively reported strong operating cash flows of $4529m in Q4, surging a huge 21.6% YoY! Running gold mines is very profitable for the major miners, they have this down to a science. Of the 26 of these major gold miners reporting Q4 OCFs, every single one was positive. Most also proved relatively large compared to individual company sizes, looking really strong.

As long as OCFs remain massively positive, the gold mines are generating much 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. Given how ridiculously low gold-stock prices are today, you'd think the gold miners are hemorrhaging cash like crazy. But the opposite is true, showing how silly this bearish herd sentiment is.

The top GDX gold miners' actual GAAP accounting profits didn't look as good, coming in at a $266m loss in Q4'17. While a big improvement over Q4'16's $588m loss, that still seems incongruent with those great all-in sustaining costs and operating cash flows. Of the 23 of these top-34 GDX components reporting earnings in Q4, 10 had losses. Half of those were big, over $50m. I looked into the reasons behind each one.

These handful of big gold-mining losses that dragged down overall top-GDX-component earnings were mostly the result of asset-impairment charges. Some of the world's largest gold miners led by Newmont and Barrick with $527m and $314m Q4 losses continued to write down the carrying value of some gold mines. As mines are dug deeper and gold prices change, the economics of producing the metal change too.

That leaves some of the major gold miners' individual mines worth less going forward than the amount of capital invested to develop them. So they are written off, resulting in big charges flushed through income statements that mask operating profits. But these writedowns are something of an accounting fiction, non-cash expenses not reflective of current operations. They are mostly isolated one-time events as well.

In addition to writedowns totally irrelevant to current and future cash flows, there were also big losses recognized in Q4'17 due to the new US corporate-tax law. With tax rates slashed, deferred tax assets that were created by overpaying taxes in past years were suddenly worth a lot less. These too were non-cash charges, another accounting fiction. Finally some companies realized losses on selling gold mines.

The major gold miners all run portfolios of multiple individual gold mines, each with different AISC levels. They've been gradually pruning out their higher-cost operations by selling those mines to smaller gold miners, usually at losses. While this hits income statements in mine-sale quarters, it is one reason the major gold miners have been able to drive down their costs. That will lead to greater future profitability.

In price-to-earnings-ratio terms, the major gold stocks are definitely getting cheaper. Of the 23 of these top-GDX-component stocks with profits to create P/E ratios, 7 had P/Es in the single or low-double digits! There are some really-cheap gold miners out there today, even adjusted for any dilution from past share issuances. Of course P/E ratios automatically do that since stock prices are divided by earnings per share.

On the sales front these top-34 GDX gold miners' revenues soared 13.9% YoY to $12,236m in Q4. That looks suspect given that 1.7% YoY drop in production and the 4.8% YoY rally in the average gold price. 26 of these gold miners reported Q4 sales, compared to 27 a year earlier in Q4'16. The apparent growth came from some large gold miners that didn't disclose Q4'16 sales deciding to make that data available in Q4'17.

Cash on balance sheets is also an interesting metric to watch, because it is primarily fed by operating profitability. Nearly all the gold miners report their quarter-ending cash balances as well, whether they report quarterly like in the US and Canada or in half-year increments like in Australia and the UK. The total cash on hand reported by these top GDX gold miners surged 7.0% YoY to a hefty $13,974m in Q4'17!

That's a big number for this small contrarian sector, and it's conservative. I just included the bank cash reported, excluding short-term investments and gold bullion. The more cash gold miners have on hand, the more flexibility they have in growing operations and the more resilience they have to weather any unforeseen challenges. Material drops in cash at individual miners were usually spent to grow their production.

So overall the major gold miners' fundamentals looked quite strong in Q4'17, a stark contrast to the miserable sentiment plaguing this sector. Gold stocks' vexing consolidation over the past year or so isn't the result of operational struggles, but purely bearish psychology. That will soon shift as stock markets inevitably roll over and gold surges, making the beaten-down gold stocks a coiled spring overdue to soar dramatically.

While investors and speculators alike can certainly play gold stocks' coming powerful uplegs with the major ETFs like GDX, the best gains by far will be won in individual gold stocks with superior fundamentals. Their upside will far exceed the ETFs, which are burdened by over-diversification and underperforming stocks. A carefully-handpicked portfolio of elite gold and silver miners will generate much-greater wealth creation.

At Zeal we've literally spent tens of thousands of hours researching individual gold stocks and markets, so we can better decide what to trade and when. As of the end of Q4, this has resulted in 983 stock trades recommended in real-time to our newsletter subscribers since 2001. Fighting the crowd to buy low and sell high is very profitable, as all these trades averaged stellar annualized realized gains of +20.2%!

The key to this success is staying informed and being contrarian. That means buying low before others figure it out, before undervalued gold stocks soar much higher. An easy way to keep abreast is through our acclaimed weekly and monthly newsletters. They draw on my vast experience, knowledge, wisdom, and ongoing research to explain what's going on in the markets, why, and how to trade them with specific stocks. For only $12 per issue, you can learn to think, trade, and thrive like contrarians. Subscribe today, and get deployed in the great gold and silver stocks in our full trading books!

The bottom line is the major gold miners' fundamentals are quite strong based on their recently-reported Q4'17 results. While production declined, mining costs were still driven lower. That coupled with higher gold prices generated fat operating profits and strong cash flows. The resulting full coffers will help the gold miners expand operations this year, which will lead to even stronger earnings growth in the future.

Yet gold stocks are now priced as if gold was half or less of current levels, which is truly fundamentally absurd! They are the last dirt-cheap sector in these euphoric, overvalued stock markets. Once gold resumes rallying on gold investment demand returning, capital will flood back into forgotten gold stocks. That will catapult them higher, continuing their overdue mean reversion back up to fundamentally-righteous levels.

Adam Hamilton, CPA

March 16, 2018

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