GDX Gold Mining Stock Fundamentals 2018 / Commodities / Gold and Silver Stocks 2018

The major gold miners’stocks are still largely grinding sideways, mired in a bearish sentimentwasteland.  Traders tend to assume lowstock prices must be righteous, reflecting weak fundamentals rather than poorpsychology.  But once a quarter earningsseasons’ bright fundamental sunlight parts the obscuring fogs of popularsentiment.  The gold miners’just-reported Q1’18 results prove they remain deeply undervalued.

Four times a yearpublicly-traded companies release treasure troves of valuable information inthe form of quarterly reports.  Companiestrading in the States are required to file 10-Qs with the US Securities andExchange 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 ofmajor gold-mining stocks to analyze comes from the world’s most-populargold-stock investment vehicle, the GDX VanEck Vectors Gold Miners ETF.  Its composition and performance are similarto the benchmark HUI gold-stock index.  GDX utterly dominatesthis sector, with no meaningful competition. This week GDX’s net assets are 25.7xlarger than the next-biggest 1x-long major-gold-miners ETF!

GDX is effectively thegold-mining industry’s blue-chip index, including the biggest and bestpublicly-traded gold miners from around the globe.  GDX inclusion is not only prestigious, but grantsgold miners better access to the vast pools of stock-market capital.  As ETF investing continues to rise, capitalinflows into leading sector ETFs require their managers to buy more shares inunderlying component companies.

GDX’s component listthis week ran 49 “Gold Miners” long. While the great majority of GDX stocks do fit that bill, it alsocontains gold-royalty companies and major silver miners.  All the world’s big primary gold minerspublicly traded in major markets are included. Every quarter I look into the latest operating and financial results ofthe top 34 GDX companies, which is just an arbitrary number fitting neatly intothese tables.

That’s a commandingsample, as GDX’s 34 largest components now account for a whopping 92.1% of its totalweighting!  These elite miners dominateworld gold mine production, which ran 770.0 metric tons in Q1’18 according tothe World Gold Council’s recently-released Q1 Gold Demand Trends report.  The top 34 GDX gold miners reportedcollectively mining 286.5t of gold last quarter, nearly 3/8ths of the world’s total!

Most of these top 34 GDXgold miners trade in the US and Canada where comprehensive quarterly reportingis required by regulators.  But sometrade in Australia and the UK, where companies just need to report in half-yearincrements.  Fortunately those goldminers do still tend to issue production reports without financial statementseach quarter.  There are still widevariations in reporting styles and data offered.

Every quarter I wadethrough a ton of data from these elite gold miners’ latest results and dump itinto a big spreadsheet for analysis.  Thehighlights make it into these tables. Blank fields mean a company had not reported that data for Q1’18 as ofthis Wednesday.  Looking at the majorgold miners’ latest results in aggregate offers valuable insights on thisindustry’s current fundamental health unrivaled anywhere else.

The first couplecolumns of these tables show each GDX component’s symbol and weighting withinthis ETF as of this week.  While most ofthese stocks trade on US exchanges, some symbols are listings from companies’primary foreign stock exchanges.  That’sfollowed by each gold miner’s Q1’18 production in ounces, which is mostly inpure-gold terms.  That excludes byproductmetals often present in gold ore.

These are mostly silverand base metals like copper, which are valuable.  They are sold to offset some of theconsiderable costs of gold mining, lowering per-ounce costs and thus raisingoverall profitability.  In cases wherecompanies didn’t separate out gold and lumped all production intogold-equivalent ounces, these GEOs are included instead.  Then production’s absolute year-over-yearchange from Q1’17 is shown.

Next comes gold miners’most-important fundamental data for investors, cash costs and all-in sustainingcosts per ounce mined.  The latterdirectly drives profitability which ultimately determines stock prices.  These key costs are also followed by YoYchanges.  Last but not least the annualchanges are shown in operating cash flows generated, hard GAAP earnings, sales,and cash on hand with a couple exceptions.

Percentage changesaren’t relevant or meaningful if data shifted from positive to negative or viceversa, or if derived from two negative numbers. So in those cases I included raw underlying data rather than weird ormisleading percentage changes.  Thiswhole dataset together offers a fantastic high-level read on how the major goldminers are faring fundamentally as an industry. And that was really well inQ1’18!

As I waded through all these gold miners’new 10-Qs or their foreign equivalents this week, the biggest surprise was production.  The whole business of gold mining is diggingup and selling gold, so naturally production is the mothers’ milk of thisindustry.  Companies are always strivingto grow their production, which boosts their cash generation and thus expansionopportunities available by finding or buying other mines.

These elite gold miners certainly had everyincentive to boost their production in Q1, since its average gold price surged 8.9% YoY to $1329.  Investors are always looking for risingproduction too, seeing it as signs of good management and strong fundamentalhealth.  Since gold stocks sufferingflagging production are often punished with selling, the major gold minersreally hate reporting it.  Yet Q1’18 wasstuffed with declines!

This wasn’t readily apparent to casualobservers, as the major gold miners carefully tailor their quarterly-resultspress releases to accentuate the positive and intentionally mask thenegative.  Yet if you look at the YoYchanges in gold production above, fully 21 of the 33 top GDX companiesreporting it suffered steep average declines of 9.6%!  This lower production was so universal andwidespread it looks to be systemic.

Overall these top 34 GDX companies mined9.2m ounces of gold in Q1’18, which was downa sharp 4.6% YoY.  This was actuallycontrary to the industry trend too.  TheWorld Gold Council’s new read on Q1’s fundamentals showed global gold mineproduction actually rising 1.4% YoY!  Yetthe top 10 GDX stocks commanding 60.3% of this ETF’s total weighting all sawgold declines averaging a major 7.4% YoY.

Most of these top gold miners hadexplanations, which were often excluded from press releases.  I found them deep in quarterly regulatoryfilings most investors will never bother looking into.  Mine sequencing leading to lower ore grades, individual-minetechnical challenges, and slowing production at older mines were mostly toblame.  This wasn’t a one-off dip though,as Q4’17’s GDX-top-34 production also fell 2.0% YoY.

Investors choosing to buy GDX instead ofindividual gold stocks with superior fundamentals must realize the lion’s shareof their investments are flowing into giant gold miners with slowing production.  Aslong as this proves true, their stocks have far-less appreciation potentialthan their smaller peers still able to grow production.  What the top major gold miners areexperiencing is increasingly validating peak-gold theses.

Gold depositseconomically viable to mine are very rare in the natural world, and thelow-hanging fruit has largely been harvested. It is growing ever more expensive to explore for gold, infar-less-hospitable places.  Then evenafter new deposits are discovered, it takes up to a decade to jump through allthe Draconian regulatory hoops necessary to secure permitting.  And only then can mine construction finallystart.

That takes additionalyears and hundreds of millions if not billions of dollars per gold mine.  But because gold-mining stocks have beendeeply out of favor most of thetime since 2013, capital has been heavilyconstrained.  When banks are bearishon gold prices, they aren’t willing to lend to gold miners except with onerousterms.  And when investors aren’t buyinggold stocks, issuing new shares low is heavily dilutive.

The large gold minersused to rely greatly on the smaller junior gold miners to explore and replenishthe gold-production pipeline.  Butjuniors have been devastated since2013, starved of capital.  Not only wereinvestors completely uninterested with general stock marketslevitating, but the rise of ETFs has funneled most investment inflows intoa handful of larger-market-cap juniors while the rest see little meaningfulbuying.

So even the world’sbiggest and best gold miners are struggling to grow production.  While that isn’t good for those individualminers, it’s super-bullish for gold.  Theless 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 world mine production will declineindefinitely.

There are strongfundamental arguments in favor of peak-gold theories.  But regardless of where overall global goldproduction heads in coming years, the major gold miners able to grow their own production will fare the best.  They’ll attract in relatively-more investorcapital, bidding their stocks to premium prices compared to peers that can’tgrow production.  Stock picking is moreimportant than ever in this ETF world!

With major gold miners’production sharply lower, their costs of mining should be proportionallyhigher.  Gold-mining costs are largelyfixed during mine-planning stages, when engineers and geologists decide whichore to mine, how to dig to it, and how to process it.  The actual mining generally requires the samelevels of infrastructure, equipment, and employees quarter after quarter.  Little changes in throughput terms.

The mills processingthe gold-bearing ore and inevitable accompanying waste rock have hard limits totonnages they can chew through.  Whenricher ore is processed, more ounces of gold are produced to spread the bigfixed costs across.  But when minemanagers have to dig through lower-grade ore, either on the way to higher-gradestuff later or in depleting mines, fewer ounces of gold must bear the full costburden.

But interestingly thisoften-ironclad inverse relationship between gold production and per-ounce costs did not really play out in Q1’18.  Costs rose, but nowhere near as much as thelower gold production implied they would. The major gold miners are getting more efficient.  They could’ve also chosen to sequencelower-grade ore into their mills because higher prevailing gold prices wouldoffset some of the production declines.

There are two majorways to measure gold-mining costs, classic cash costs per ounce and thesuperior all-in sustaining costs per ounce. Both are useful metrics.  Cashcosts are the acid test of gold-miner survivability in lower-gold-priceenvironments, revealing the worst-case gold levels necessary to keep the minesrunning.  All-in sustaining costs showwhere gold needs to trade to maintain current mining tempos indefinitely.

Cash costs naturallyencompass all cash expenses necessaryto 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 34GDX-component gold miners that reported cash costs averaged $667 perounce.  They indeed surged a sharp 7.1%YoY, the result of fixed costs spread across lower production.

These industry-widecash costs are the gold-price pain point where miners’ viability andsurvivability is in jeopardy.  Seeinggold anywhere near those levels again is exceedingly unlikely.  The last time gold hit $667 was 10.7 years ago in August 2007,before trillions of dollars of central-bank money printing after 2008’s stock panic.  Provocatively the HUI gold-stock index wasnear 320 then, 80% higher than today’s levels!

Way more important thancash costs are the far-superior all-in sustaining costs.  They were introduced by the World GoldCouncil in June 2013 to give investors a much-better understanding of what itreally costs to maintain gold mines as ongoing concerns.  AISCs include all direct cash costs, but thenadd on everything else that is necessary tomaintain and replenish operations at current gold-production levels.

These additionalexpenses include exploration for new gold to mine to replace depletingdeposits, mine-development and construction expenses, remediation, and minereclamation.  They also include thecorporate-level administration expenses necessary to oversee gold mines.  All-in sustaining costs are themost-important gold-mining cost metric by far for investors, revealing goldminers’ true operating profitability.

With the top 34 GDXgold miners’ production down 4.6% YoY in Q1, I would’ve bet their AISCswould’ve risen a proportional 4% to 5%. Yet their cost control was outstanding, as these elite gold minersreported average AISCs up just 0.7% YoY to$884 per ounce!  That’s roughly inline with the quarterly trend from 2017 seeing $878, $867, $868, and $858averages running from Q1 to Q4.  Costsare really being contained.

The major gold minershave to manage costs exceptionally well to maintain AISCs while production isalso slowing.  This argues against thepopular 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 fundamentalproblems.  But it’s relentlessly-bearish herd sentiment suppressing gold-stock prices.

Flat AISCs combinedwith sharply-higher gold prices led to explodingoperating profitability among the major gold miners last quarter!  That certainly isn’t being reflected in theirstock prices.  In Q1’17, gold averaged just$1220 against $878 average AISCs.  Thatyielded per-ounce profits of $342.  Butthis past year saw gold surge 8.9% to that $1329 quarterly average in Q1’18while AISCs only climbed 0.7% to $884.

That drove fatoperating margins of $445 per ounce, exploding 30.2% higher YoY!  That works out to excellent 3.4x upside profits leverage togold!  In any other stock-market sectorsuch massive earnings growth would be crowed about from the rooftops andcapital would flood in.  But that wasn’tenough to blow away the darkening bearish pall over gold stocks.  GDX’s average share price still fell 3.0% YoYin Q1’18!

Gold-stock profits asmeasured by the difference between average gold prices and average AISCs evensurged 6.3% quarter-on-quarter from Q4’17. There is a vast fundamentaldisconnect between the left-for-dead gold-stock prices and gold miners’strong operational performances.  Thisbearish-sentiment-driven anomaly is very extreme and won’t last forever.  Investors will rush back in when theydiscover the value.

The major gold miners’fundamental health is reflected in their operating-cash-flow generation.  These top 34 GDX gold miners reporting OCFsfor last quarter collectively produced $3355m. That’s up 3.9% YoY despite their 4.6% lower gold production, mostly dueto that sizable 8.9% average-gold-price rally. Most of these elite gold miners saw big annual growth in cash generatedfrom operations, a very-bullish sign.

As long as OCFs remainmassively positive, the gold mines are generating much more cash than they costto run.  That gives the gold miners thecapital necessary to expand existing operations and buy new deposits andmines.  Given how ridiculously lowgold-stock prices are today, you’d think the gold miners are hemorrhaging cashlike crazy.  But the opposite is true,showing how silly this bearish herd sentiment is.

These top GDX goldminers’ actual GAAP profits didn’t look as good, plunging 48.5% YoY to $855m inQ1.  While that was a huge improvementover Q4’17’s $266m loss, it still seems incongruent with those flat all-insustaining costs and growing operating cash flows.  Of the 25 of these top GDX componentsreporting earnings in Q1, just 3 had losses. The only big ones came from Royal Gold and Yamana Gold.

Royal Gold’s $154m losswas the result of a gigantic $239m impairment charge in its interests in goldroyalties.  That came from Barrick Gold’sbig Pascua-Lama project, which straddles the border between Chile and Argentina.  In Q1 Barrick decided the current economicand geopolitical environment made the Chilean side of this project not worthyof further investment.  Chile’sgovernment is harassing Barrick on it.

Yamana Gold’s $161mloss was largely from a $103m impairment of a majority investment it made in asmaller gold company.  When a thirdcompany agreed to acquire all the shares of that smaller miner in Q1, Yamanahad to write off its loss.  These twoimpairments alone battered overall GDX GAAP profits $342m lower!  Without them, the top 34 GDX gold miners’earnings would’ve slid a much-smaller 27.9% YoY.

It doesn’t take many ofthese non-cash charges to greatly alter the collective GAAP earnings of theelite gold miners.  And there’s a third hugeone to consider.  Back in Q1’17, BarrickGold recorded a colossal $1125m non-cashgain reversing previous impairment charges on a gold project after Goldcorpagreed to buy a quarter of it.  Thatreally inflated overall GDX GAAP profits in the comparable quarter a year ago.

Just excluding that hugeQ1’17 impairment reversal and that pair of Q1’18 impairment charges radicallychanges the profits picture.  Again thosewere non-cash and had nothing to do with operations.  That yields Q1’18 GAAP profits of $1197m forthese top 34 GDX gold miners, a staggering $123%higher than Q1’17’s if its Barrick impairment-reversal gain hadn’thappened!  The major gold miners arefaring really well.

These surgingaccounting earnings are evident in the classic trailing-twelve-monthprice-to-earnings ratios of these top gold miners as well.  They aren’t included in these tables, butaveraged 37.3x in Q1’18 for the 24 of these companies that had net earningsover the past year.  While that’s not anaccurate reflection of true valuations due to non-cash things flushed throughincome statements, it was still 28% lower.

On the sales frontthese top 34 GDX gold miners’ revenues climbed 1.5% YoY to $10.6b inQ1’18.  That reflects the combination ofhigher gold selling prices with lower gold production.  Actual sales growth was probably better, as26 top-34 GDX companies reported sales in Q1’18 compared to 28 in Q1’17.  GDX saw three new companies climb into theranks of its top 34 over this past year, highlighted in light blue above.

Two of these are thegreat low-cost Australian gold miners Regis Resources and St Barbara Limited.  They report in half-year increments, and gaveno revenues data for Q1 which was an interim quarter for both.  The companies they knocked out of the top 34had reported sales a year earlier.  Sothe sales growth in the elite major gold miners was really good consideringtheir sharply-lower gold production.

Finally these top 34GDX gold miners’ cash on their balance sheets fell 4.2% YoY to $12.7b.  That’s a big number for this small contrariansector, meaning these companies have lots of capital firepower available toexpand existing operations or buy gold mines from other companies.  The more cash on hand the gold miners have,the more flexibility and resilience they have to grow their businesses andweather challenges.

So overall the majorgold miners’ fundamentals looked reallystrong in Q1’18, a stark contrast to the miserable sentiment plaguing thissector.  Gold stocks’ vexing consolidation sinceearly 2017 isn’t the result of operational struggles, but purely bearishpsychology.  That will soon shift asstock markets inevitably roll over and gold surges, making the beaten-down goldstocks a coiled spring overdue to soar dramatically.

While investors and speculators alike cancertainly play gold stocks’ coming powerful uplegs with the major ETFs likeGDX, the best gains by far will be won in individual gold stocks with superiorfundamentals.  Their upside will farexceed the ETFs, which are burdened by over-diversification and underperformingstocks.  A carefully-handpicked portfolioof elite gold and silver miners will generate much-greater wealth creation.

At Zeal we’ve literally spent tens of thousands of hours researchingindividual gold stocks and markets, so we can better decide what to trade andwhen.  As of the end of Q4, this hasresulted in 983 stock trades recommended in real-time to our newslettersubscribers since 2001.  Fighting thecrowd to buy low and sell high is very profitable, as all these trades averagedstellar annualized realized gains of +20.2%!

The key to this success is staying informed and beingcontrarian.  That means buying low beforeothers figure it out, before undervalued gold stocks soar much higher.  An easy way to keep abreast is through ouracclaimed 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 likecontrarians.  Subscribe today, and getdeployed in the great gold and silver stocks in our full trading books!

The bottom line is themajor gold miners’ fundamentals are really strong based on theirrecently-reported Q1’18 results.  Whileproduction declined fairly sharply, the miners still held the line on all-insustaining costs.  That fueled fatoperating profits and strong cash flows. And many of the elite gold miners have forecast improving productionthroughout 2018 on higher-grade ores, which will push profits even higher.

Yet gold stocks arepriced today as if gold was half or less of current levels, which is trulyfundamentally-absurd!  They are the lastsuper-undervalued sector in these euphoric, overvalued stock markets.  When gold investment demand resumes onweakening stock markets and pushes gold higher, capital will flood back intothe forgotten gold miners.  That buying willcatapult them back to far-higher fundamentally-righteous prices.

Adam Hamilton, CPA

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