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

The gold miners’ stocksremain deeply out of favor, trading at prices seen when gold was half or even aquarter of current levels.  So manytraders assume this small contrarian sector must be really struggling fundamentally.  But nothing could be farther from thetruth!  The major gold miners’recently-released Q4’17 results prove they are thriving.  Their languishing stock prices are the resultof irrational herd sentiment.

Four times a yearpublicly-traded companies release treasure troves of valuable information inthe form of quarterly reports.  Requiredby securities regulators, these quarterly results are exceedingly important forinvestors and speculators.  They dispelall the sentimental distortions surrounding prevailing stock-price levels,revealing the underlying hard fundamentalrealities.  They serve to re-anchorperceptions.

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

So it takes companiesmore time to prepare full-year financials and then get them audited by CPAsright 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 minersdon’t actually break out Q4 separately. Instead they only report full-year results, lumping in and obscuring Q4.

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

All this unfortunatelymakes Q4 results the hardest to analyze out of all quarterlies.  But delving into them is still well worth thechallenge.  There’s no better fundamentaldata available to gold-stock investors and speculators than quarterly results,so they can’t be ignored.  They offer avery valuable true snapshot of what’s really going on, shattering all themisconceptions bred by the ever-shifting winds of sentiment.

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 24.4xlarger than the next-biggest 1x-long major-gold-miners ETF!

Being included in GDXis the gold standard for gold miners, requiring deep analysis and vetting byelite analysts.  And due to ETF investingeclipsing individual-stock investing, major-ETF inclusion is one of themost-important considerations for picking great gold stocks.  As the vast pools of fund capital flow intoleading ETFs, these ETFs in turn buy shares in their underlying companiesbidding their stock prices higher.

This week GDX includeda whopping 51 component “Gold Miners”. That term is used somewhat loosely, as this ETF also contains majorsilver miners, a silver streamer, and gold royalty companies.  Still, all the world’s major gold miners areGDX components.  Due to time constraintsI limited my deep individual-company research to this ETF’s top 34 stocks, anarbitrary number that fits neatly into the tables below.

Collectively GDX’s 34largest components now account for 90.5% of its total weighting, a commandingsample.  GDX’s stocks include majorforeign gold miners trading in Australia, Canada, and the UK.  Some countries’ regulations require financialreporting in half-year incrementsinstead of quarterly, which limits local gold miners’ Q4 data.  But some foreign companies still choose topublish limited quarterly results.

The importance of thesetop-GDX-component gold miners can’t be overstated.  In Q4’17 they collectively produced over 10.3mounces 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 totalglobal mine production at 833.1t in Q4.  GDX’stop 34 miners alone accounted for nearly4/10ths!

Every quarter I wadethrough a ton of data from these elite gold miners’ 10-Qs or 10-Ks, and dump itinto a big spreadsheet for analysis.  Thehighlights made it into these tables.  Blankfields mean a company did not report that data for Q4’17 as of thisWednesday.  Naturally companies alwaystry to present their quarterly results in the best-possible light, which leadsto wide variations in reporting styles and data offered.

In these tables thefirst couple columns show each GDX component’s symbol and weighting within thisETF as of this week.  While most of thesegold 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 goldproduction in ounces, which is mostly reported in pure-gold terms.

Many gold miners alsoproduce byproduct metals like silver and copper.  These are valuable, as they are sold tooffset some of the considerable costs of gold mining.  Some companies report their quarterly goldproduction including silver, a construct called gold-equivalent ounces.  I only included GEOs if no pure-gold numberswere reported.  That’s followed byproduction’s absolute year-over-year change from Q4’16.

Next comes themost-important fundamental data for gold miners, cash costs and all-insustaining costs per ounce mined.  Thelatter determines their profitability and hence ultimately stock prices.  Those are also followed by YoY changes.  Finally the YoY changes in cash flowsgenerated from operations, GAAP profits, revenues, and cash on balance sheetsare listed.  There are a couple exceptionsto these YoY changes.

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 numbers instead of weird ormisleading percentage changes.  Thiswhole dataset offers a fantastic high-level read on how the major gold minersare faring today as an industry.  Andcontrary to their low stock prices, theyare thriving!

After spending daysdigesting these elite gold miners’ latest quarterly reports, it’s fullyapparent their vexing consolidation over the past year or so isn’tfundamentally-righteous at all!  Tradershave mostly abandoned this sector because the allure of the levitating general stock markets has eclipsed gold.  That has left goldstocks exceedingly undervalued, truly the best fundamental bargains out therein all the stock markets!

Since gold miners arein the business of wresting gold from the bowels of the Earth, production isthe best place to start.  The 10,337kounces of gold collectively produced last quarter by these elite major goldminers actually fell a sizable 1.7% YoY! Interestingly that’s right in line with industry trends per the WorldGold Council, as overall world gold mine production also retreated that same1.7% YoY in Q4’17.

These biggest and bestgold miners on the planet certainly had every incentive to grow their goldproduction.  The quarterly average goldprice surged 4.8% YoY in Q4’17, really boosting profitability.  Of course the more gold any miner canproduce, the more opportunities it has to expand thanks to higher cashflows.  Investors often punish flaggingproduction too, so the major gold miners really hate reporting it.

Most investors won’tbother studying long and detailed 10-Qs, 10-Ks, or the accompanying managementdiscussions and analyses.  So gold minersoften issue short press releases summarizing some of their quarterlyresults.  These sometimes intentionally mask production declinesby excluding year-ago production, looking at quarter-on-quarter performanceinstead 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 hugeamount of time analyzing quarterly results. And I remain a CPA after my previous late-1990s gig auditing miningcompanies for a Big Six firm.  Yet evenwith this exceptional experience and knowledge, I’m still surprised how deeplyI have to dig for some key results miners bury and hide inhundred-plus-page-long SEC filings.

So believe me, majorgold miners don’t shout out shrinking gold production from the rooftops.  Yet of the 32 of these top-34 GDX gold minersreporting 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 34components over the past year, which are highlighted in blue above.  The average production decline was a serious9.5% YoY!

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 ofthe time 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 heavily on the smaller junior gold miners to explore and replenishthe gold-production pipeline.  Butjuniors have been devastated since2013, starved of capital.  Not only areinvestors completely uninterested with general stock markets levitating, butthe rise of ETFs has funneled most investment inflows into a handful oflarger-market-cap juniors while the rest see little meaningful buying.

So even the world’sbiggest and best gold miners are struggling to grow production.  While that isn’t great 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 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 ownproduction will fare the best.  They’llattract in relatively-more investor capital, bidding their stocks to premiumprices compared to peers who can’t grow production.  Stockpicking is more important than ever in this ETF world!

But despite slowinggold production, these top-34 GDX-component gold miners remained quite strong fundamentally in Q4!  Their viability and profitability aremeasured by the differences between prevailing gold prices and what it costs toproduce that gold.  Despite traders’erroneous perception gold stocks are doomed, rising gold prices and fallingmining costs are making the major gold miners much more profitable.

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 Q4’17, these top-34GDX-component gold miners that reported cash costs averaged just $600 perounce.  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 injeopardy.  This week the flagship HUIgold-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 collectivelyface zero threat of bankruptcies unless gold plummets under $600.

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.  AISC 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.

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

Gold-mining costs arelargely fixed during mine-planning stages, when engineers and geologists decidewhich ore 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.  So the more gold mined, the more ounces tospread those big fixed costs across. Thus production and AISCs are usually negatively correlated.

The major gold minershave to manage costs exceptionally well to drive AISCs lower while productionis also 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 fundamental problems.  But it’s relentlessly-bearishherd sentiment suppressing gold-stock prices.

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

A year earlier inQ4’16, the top-34 GDX gold miners reported average AISCs of $875 in aquarter where gold averaged under $1218. That made for $343 per ounce in operating profits.  So in Q4’17, the major gold miners’ earningssoared 22.1% YoY to $418 on that mere 4.8% gold rally!  Gold miners make such compelling investmentopportunities because of their inherentprofits leverage to gold, multiplying its gains.

But this strongprofitability 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 disconnectin gold-stock prices today is absurd, and can’t last forever.  Sooner or later investors will rush into the left-for-deadgold stocks to bid their prices far higher. This bearish-sentiment-driven anomaly has grown more extreme in 2018.

Since gold-mining costsdon’t change much quarter-to-quarter regardless of prevailing gold prices, it’sreasonable to assume the top GDX miners’ AISCs will largely hold steady in thecurrent Q1’18.  And it’s been a strongquarter 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 amassive 12.7% QoQ jump in earnings for the major gold miners in this currentquarter!  Yet so far in Q1 the HUI isaveraging just 187.1, worse than both Q4’17 and Q4’16 when gold prices wereconsiderably lower and mining costs were higher.  The gold miners’ stocks can’t trade as iftheir profits don’t matter forever, so an enormous mean-reversion rally higher is inevitable sometime soon.

And that assumes goldprices merely hold steady, which is unlikely. After years of relentlessly-levitating stock markets thanks to extremecentral-bank easing, radicalgold 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 highergold prices ahead.

The impact of highergold prices on major-gold-miner profitability is easy to model.  Assuming flat all-in sustaining costs atQ4’17’s $858 per ounce, 10%, 20%, and 30% gold rallies from this week’s levels wouldlead to collective gold-mining profits surging 43%, 75%, and 107%!  And another 30% gold upleg isn’t a stretch atall.  In the first half of 2016 aloneafter the previous stock-market correction, gold soared 29.9%.

GDX skyrocketed 151.2% higher in 6.4 months inessentially that same span!  Gold-miningprofits and thus gold-stock prices surge dramatically when gold is poweringhigher.  Years of neglect from investorshave forced the gold miners to get lean and efficient, which will amplify theirfundamental upside during the next major gold upleg.  The investors and speculators who buy inearly and cheap could earn fortunes.

While all-in sustainingcosts are the single-most-important fundamental measure that investors need tokeep an eye on, other metrics offer peripheral reads on the major gold miners’fundamental health.  The more importantones include cash flows generated from operations, actual accounting profits,revenues, and cash on hand.  Theygenerally corroborated AISCs in Q4’17, proving the gold miners are faringreally well.

These top-34GDX-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 havethis down to a science.  Of the 26 ofthese major gold miners reporting Q4 OCFs, every single one was positive.  Most also proved relatively large compared toindividual company sizes, looking really strong.

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 and mines.  Given how ridiculously low gold-stock pricesare today, you’d think the gold miners are hemorrhaging cash like crazy.  But the opposite is true, showing how sillythis bearish herd sentiment is.

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

These handful of biggold-mining losses that dragged down overall top-GDX-component earnings weremostly 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 towrite down the carrying value of some gold mines.  As mines are dug deeper and gold priceschange, the economics of producing the metal change too.

That leaves some of themajor gold miners’ individual mines worth less going forward than the amount ofcapital invested to develop them.  Sothey are written off, resulting in big charges flushed through incomestatements that mask operating profits. But these writedowns are something of an accounting fiction, non-cash expenses not reflective ofcurrent operations.  They are mostlyisolated one-time events as well.

In addition towritedowns totally irrelevant to current and future cash flows, there were alsobig losses recognized in Q4’17 due to the newUS corporate-tax law.  With tax ratesslashed, deferred tax assets that were created by overpaying taxes in pastyears were suddenly worth a lot less. These too were non-cash charges, another accounting fiction.  Finally some companies realized losses onselling gold mines.

The major gold minersall run portfolios of multiple individual gold mines, each with different AISClevels.  They’ve been gradually pruningout their higher-cost operations by selling those mines to smaller gold miners,usually at losses.  While this hitsincome statements in mine-sale quarters, it is one reason the major gold minershave been able to drive down their costs. That will lead to greater future profitability.

Inprice-to-earnings-ratio terms, the major gold stocks are definitely gettingcheaper.  Of the 23 of these top-GDX-componentstocks with profits to create P/E ratios, 7 had P/Es in the single orlow-double digits!  There are some really-cheapgold miners out there today, even adjusted for any dilution from past shareissuances.  Of course P/E ratios automaticallydo that since stock prices are divided by earningsper share.

On the sales frontthese top-34 GDX gold miners’ revenues soared 13.9% YoY to $12,236m in Q4.  That looks suspect given that 1.7% YoY dropin 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’tdisclose Q4’16 sales deciding to make that data available in Q4’17.

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

That’s a big number forthis 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, themore flexibility they have in growing operations and the more resilience theyhave to weather any unforeseen challenges. Material drops in cash at individual miners were usually spent to growtheir production.

So overall the majorgold miners’ fundamentals looked quite strong in Q4’17, a stark contrast to themiserable sentiment plaguing this sector. Gold stocks’ vexing consolidation over the past year or so isn’t theresult 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 the crowdto 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 like contrarians.  Subscribetoday, and get deployed in the great gold and silver stocks in our fulltrading books!

The bottom line is themajor gold miners’ fundamentals are quite strong based on theirrecently-reported Q4’17 results.  Whileproduction declined, mining costs were still driven lower.  That coupled with higher gold pricesgenerated fat operating profits and strong cash flows.  The resulting full coffers will help the goldminers expand operations this year, which will lead to even stronger earningsgrowth in the future.

Yet gold stocks are nowpriced as if gold was half or less of current levels, which is trulyfundamentally absurd!  They are the lastdirt-cheap sector in these euphoric, overvalued stock markets.  Once gold resumes rallying on gold investmentdemand returning, capital will flood back into forgotten gold stocks.  That will catapult them higher, continuingtheir overdue mean reversion back up to fundamentally-righteous levels.

Adam Hamilton, CPA

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