GDX Gold Mining Stocks Q3 18 Fundamentals / Commodities / Gold and Silver Stocks 2018

The major gold miners’stocks remain mired in universal bearishness, largely left for dead.  They are just wrapping up their third-quarterearnings season, which proved challenging. Lower gold prices cut deeply into cash flows and profits, andproduction-growth struggles persisted. But these elite companies did hold the line on costs, portending soaringearnings as gold recovers.  Their absurdly-cheapstock prices aren’t justified.

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 40 calendar days after quarter-ends.  Canadian companies have similar requirementsat 45 days.  In other countries withhalf-year reporting, many companies still partially report quarterly.

These quarterlies offerthe best fundamental data available for individual major gold miners, showinghow their operations are really faring. That helps dispel the thick obscuring fogs of sentiment that billow up therest of the time.  While I always eagerlyanticipate perusing these key reports, I worried what this Q3’18 earningsseason would reveal.  Lower gold prices,flagging production, and weak sentiment are a witches’ brew.

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 50.5xlarger 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, butgrants gold miners better access to the vast pools of stock-marketcapital.  As ETF investing continues torise, capital inflows into leading sector ETFs require their managers to buymore shares in underlying component companies.

My earnings-seasontrepidation soared on October 25th.  The goldstocks were doing fairly well then, with GDX rallying 14.4% out ofmid-September’s deep forced-capitulationlows.  Sentiment was slowly improving.  But that day GDX plunged 4.4% out of theblue, and the flat gold price at upleghighs certainly wasn’t the driver.  Themost-loved major gold miner had plummeted after reporting shockingly-bad Q3results.

Goldcorp has alwaysbeen one of GDX’s top components.  Itreported mining just 503k ounces of gold last quarter, which plunged 11.9%sequentially quarter-on-quarter and 20.5% year-over-year!  That forced its all-in sustaining costs aproportional 20.8% higher YoY to $999 per ounce.  Investors panicked and fled, hammering GGstock 18.7% lower.  That was the worst downday in the 24.6-year history of this company.

That left it at anextreme 16.2-year low!  GG hadn’t beenlower since August 2002 when gold was still in the low $300s, it was apocalyptic.  That really torpedoed still-fragile sentimentin this sector, even though GG’s woes lookedshort-lived.  It was bringing a newexpansion online at one of its big mines, which was what caused the shortfall.  Now in Q4’18 Goldcorp expects production torebound to 620k ounces at $750 AISCs.

After GG’s Q3 disaster,I worried frayed investors would dump other gold stocks on any hints ofless-than-optimal quarterly results.  ButGDX has ground sideways on balance since that GG shock, weathering this riskyearnings season with sentiment so fragile. Ever since I’ve been anxious to analyze the collective Q3 results of themajor gold miners as a whole, to see if GG’s travails were unique to it or moresystemic.

GDX’s component listthis week ran 48 “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 93.5% of itstotal weighting!  These elite miners thatreported Q3’18 results produced 296.4 metric tons of gold, which accounts forfully 33.9% of last quarter’s total global gold production.  That ran 875.3t per the recently-released Q3’18Gold Demand Trends report from the World Gold Council.  I’ll discuss production more below.

Most of these top 34GDX gold miners trade in the US and Canada where comprehensive quarterlyreporting is required by regulators.  Butsome trade in Australia and the UK, where companies just need to report inhalf-year increments.  Fortunately thosegold miners do still tend to issue production reports without financialstatements each quarter.  There are stillwide variations in reporting styles and data offered.

Every quarter I wadethrough a ton of data from these major 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 Q3’18 as ofthis Wednesday.  Looking at the majorgold miners’ latest results in aggregate offers valuable insights on this industry’s current fundamental healthunrivaled 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 Q3’18 production in ounces, which is mostly inpure-gold terms.  That excludes byproductmetals often present in gold ore.

Those are usuallysilver and 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 into gold-equivalentounces, those GEOs are included instead. Then production’s absolute year-over-year change from Q3’17 is shown.

Next comes gold miners’most-important fundamental data for investors, cash costs and all-in sustainingcosts per ounce mined.  The latter directlydrives profitability which ultimately determines stock prices.  These key costs are also followed by YoYchanges.  Last but not least the annual changesare shown in operating cash flows generated, hard GAAP earnings, revenues, andcash 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. Was Goldcorp’s disaster systemic?

Production has alwaysbeen the lifeblood of the gold-mining industry, since the gold miners can easilysell every ounce they can wrest from the bowels of the earth.  While the gold price is also important,generally the more gold they mine the greater their operating cash flows andprofits.  That generates more capital to investin future production, which comes from expanding existing mines and building orbuying new ones.

Gold-stock investorshave long prized production growth above everything else, as it is inexorably linked to company growth and thusstock-price-appreciation potential.  Butfor some years now the major gold miners have been struggling to growproduction.  Large economically-viablegold deposits are getting increasingly harder to find and more expensive to exploit,with the low-hanging fruit long since picked.

More and moregold-industry experts believe peak gold is nearing, after which global mine production will start declining.  For many years now new deposit discoveriesand mine builds have failed to keep pace with depletion at existing mines.  So production growth is slowing.  According to the World Gold Council’s latestfundamental data, global mine production only edged 0.8% higher in 2017compared to 5.3% in 2013!

GDX’s major gold minersare the biggest and best in the world, with access to many billions of dollarsof capital to expand their operations. Yet many of them are still having trouble finding and adding enough newproduction to offset the normal declines in their aging operations.  So while Goldcorp’s Q3 production plunge wasextreme, it certainly wasn’t unique.  Outof GDX’s top 10 miners by Q3 ounces, 9 saw YoY declines!

GG’s anomalous 20.5%was definitely the worst.  But the 4largest gold miners last quarter Newmont, Barrick, AngloGold, and Kinross sufferedproduction drops of 2.0%, 7.6%, 14.6%, and 10.4% YoY in Q3.  Excluding Goldcorp, those other 8 of the top10 still averaged hefty 8.2% YoY declines last quarter.  That’s pretty serious by any standard.  Overall the top 34 GDX miners’ goldproduction retreated 2.9% YoY to 9.5mozs!

So on the productionfront they are doing worse than this industry as a whole.  That latest Q3 GDT data from the WGC reports overallglobal mine production actually grew 1.9% YoY last quarter.  So the majors are really lagging their peersand dragging down the average.  Andseeing their production declines mount is even more striking in a third quarter.  Q3s tend to see strong production growth headinginto year-ends.

Mine managers want to maximizetheir annual bonuses, which are often tied to the performances of their companies’stocks.  With Q3 results released 6 to 9weeks before year-ends, they can really help fuel big late-year stock ralliesif good enough.  So the managers tend tosequence their processing to ensure that higher-grade ores are fed into theirmills in Q3s, yielding more ouncesproduced despite fixed mill throughputs.

Within individual golddeposits, ore grades vary considerably. Mine managers have to decide which parts of the deposits they are goingto dig and haul in any given quarter, and when to run that ore through themills.  They seem to like to processtheir higher-grade ores in Q3s when bonus calculations are nearing, and theirlower-grade ores in Q1s when year-ends are far away.  This surprising herd behavior is well-documented.

Again per that comprehensivefundamental data from the WGC, over the last 8 years including 2018 global goldmine production has dropped an average of 9.0% QoQ from Q4s to Q1s!  Every one of these transitions was negative,ranging from -6.7% to -12.0%.  The minemanagers collectively want to take the lower-ore-grade production hits early inyears.  They stockpile their better higher-gradeore for processing in Q3s.

In that same span between2011 to 2018, global gold mine production has surged an average of 6.6% higherQoQ from Q2s to Q3s!  Every single yearsaw positive growth between +4.4% to +9.1%. There’s no doubt the top GDX gold miners really wanted to show big Q3’18 production growth as well, tomaximize Q4 stock-price gains and managers’ compensation.  But ominously they still couldn’t pull it offlast quarter.

Three big South Africangold miners AngloGold, Gold Fields, and Sibanye Gold didn’t break out their Q2’18 gold production in that priorearnings season.  They instead lumped itinto half-year reporting, likely to mask slowing production.  But they did report it in Q3’18 in theirquarterly operational updates.  So if weexclude them, the rest of the GDX top 34’s gold production merely grew 1.1% QoQin Q3 which is really slow.

If the world’s top goldminers couldn’t scrounge up enough higher-grade ore to report strong Q3s, they are really hurting on theproduction front!  As I’ve warned foryears, investors can and should avoid most of the majors because of this.  Growing gold production is always challenging,but incredibly difficult off of really-high bases.  The best production growth and stock-priceupside comes from the smaller mid-tier miners.

Unfortunately themajors’ flagging production is a vexing problem for this entire sector becausethese large companies dominate GDX and the gold-stock indexes.  Speculators and investors alike look to theirperformances to gauge how gold stocks are faring, which heavily colors theirpsychology and perceptions on gold miners’ potential.  So the majors’ production struggles weighing down the indexes exacerbates bearishness.

Q3’s disappointmentwasn’t something new either, as the top 34 GDX gold miners also reported sharp Q2’18 production declines of 7.7% YoY.  The majors are starting toget desperate since they can’t bring their own new projects online fast enoughto offset existing-mine depletion.  Sothey are looking to buy other operating mines and even entire companies at highpremiums to restore their flagging production growth.

We just saw a huge examplelate in Q3, when Barrick announced it was merging with Randgold!  The world’s 2nd-largest gold miner and GDX componentwas effectively buying the 10th-largest gold miner and 7th-largest GDX componentin an all-stock deal.  The combined companywould’ve been the world’s largest gold miner in Q3 at 1458k ozs.  But with production waning at both ABX andGOLD, the problem remains.

While Q3’18’sunderperformance by the biggest gold miners dominating GDX was striking, it isnothing new.  That’s why I’ve longrecommended investors avoid many of the largest gold miners.  Mid-tier miners with growing production as they bring new mines online andmuch-smaller market caps have far-greater upside potential during golduplegs.  They are bucking theincreasingly-evident peak-gold predicament.

Peak gold is likelybearish for the largest gold miners that drive GDX.  Capital inflows from investors will wanealong with their shrinking production.  Butlower gold mined supply on balance going forward is wildly bullish for the mid-tier and junior gold miners growingtheir production!  The resulting highergold prices will catapult their profits and thus stock prices far higher,attracting investors fleeing the struggling majors.

The only way to reapthese massive gains is directly investingin the best individual gold miners. Their fundamentals are far superior to their sector’s as a whole.  While buying GDX is easy, the lion’s share ofthat capital is funneled into the major gold miners with slowingproduction.  Their underperformance will diluteaway any outperformance among mid-tier miners in this ETF, leading to mediocre overallgains.

With many of the majorgold miners’ seeing lower or stagnant production, their mining costs should’verisen proportionally.  Gold-mining costsare largely fixed quarter after quarter, with actual mining requiring the samelevels of infrastructure, equipment, and employees.  So the lower production, the fewer ounces tospread mining’s big fixed costs across. The silver lining to the gold majors’ Q3 is they held the line on costs.

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, andtax expenses.  In Q3’18, these top 34GDX-component gold miners that reported cash costs averaged $631 perounce.  That was indeed up 6.8% YoY, but stillradically below even gold’s $1174 mid-August low.

That was an anomalydriven by all-time-record gold-futures short selling by speculators.  The gold miners face noexistential peril as long as prevailing gold prices are well above their cashcosts of production.  Interestingly muchof that extreme gold-futures short selling has yet to be unwound, which means gold-upleg fuel stillabounds.  The gold stocks leverage gold’smoves since its price levels drive their profitability.

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.

Back in late Octoberwhen Goldcorp’s horrible Q3 wrecked gold-stock sentiment, I feared soaringAISCs might be the norm last quarter. Remember GG’s AISCs soared 20.8% YoY on its 20.5% production drop, perfectlyinversely proportional.  So it was apleasant surprise to see these top 34 GDX gold miners even including GG fullycontain their average AISCs in Q3.  They only rose 1.0% YoY to $877 per ounce, abig victory!

That’s right in linewith the previous four quarters’ $868, $858, $884, and $856 averaging $867.  So while the gold majors have production-growthproblems, they are not manifesting on the cost front.  These elite companies are optimizing existingmines to lower production costs and choosing new mine builds that are cheaper tooperate.  That bodes well for thisindustry going forward, portending surging profits as gold recovers.

Gold-mining earningsare simply the difference between prevailing gold prices and all-in sustainingcosts.  In Q3 gold averaged $1211 perounce, implying average profits of $334 at $877 average AISCs.  That is still pretty impressive, implyingsolid 28% profit margins even in a weak quarter for gold prices.  So GDX getting pounded to a 2.6-year low in mid-September on forced selling as stopswere run wasn’t justified.

Those recent gold-stocklows were actually fundamentallyabsurd, resulting from irrational excessively-bearish sentiment.  They had nothing to do with fundamentals.  GDX was back down near its stock-panic lowsfrom October 2008, when gold was languishing under $750.  Seeing gold-stock prices revisit those levelsin recent months with gold prices over 55%higher made no sense at all!  Goldstocks are far too low.

That’s true even thoughQ3 was a tough quarter.  It wasn’t justthe production challenges, but that $1211 average gold price in Q3’18 was 5.3% under its Q3’17 average.  Gold miners’ earnings leverage both upside anddownside gold-price moves, really hurting profitability.  In Q3’17 these top 34 GDX miners were earning$411 per ounce on average, so industry profits fell 18.7% YoY making for 3.6xdownside leverage.

The lower prevailinggold prices along with flat-to-lower gold production certainly weakened thenormal accounting metrics of major gold miners’ health.  The cash flows generated from operations bythese top GDX components plunged 29.0% YoY to $3155m.  Revenues dropped 7.4% YoY to $9599m, mostly dueto lower gold prices but also reflecting 9.2% lower byproduct silver productionamong these major gold miners.

And their hard GAAP earningsreported to regulators looked ugly, weighing in at a considerable $566m collectiveloss in Q3’18 compared to $854m of profits in Q3’17!  While lower gold prices naturally lead tolower profits, that was far beyond what gold’s drop warranted.  But thankfully this latest quarter’s profitswere greatly skewed to the downside by a couple of huge mine-impairment chargesfrom GDX’s biggest components.

When gold deposits lookless economically viable due to weaker gold prices or tougher geology than wasoriginally expected, miners write down their carrying values which flushes big non-cash losses through their incomestatements.  Newmont reported a $366mimpairment charge in Q3 on some of its exploration properties in NorthAmerica.  Barrick ran through an even-larger$431m writedown in Q3 on a mine in Peru.

Both of these bigimpairment charges turned operating profits at the world’s two biggest goldminers into deep losses.  If they areexcluded, the top 34 GDX gold miners earned $231m in Q3’18.  While still down an ugly 73.0% YoY, at leastthe major gold miners were still earning money last quarter.  So there was nothing particularly troublingon the hard-GAAP-earnings front in Q3, but it was still really weak for goldminers.

But they remain readyto expand, collectively sitting on a big $11.7b cash hoard at the end of Q3’18.  That was merely down 0.4% YoY, reflecting relatively-solidoperating cash flows and access to financing capital.  I suspect some of this will be deployed inbuying up smaller gold miners with operating mines, since it takes over a decadeto bring new deposits into production.  The major gold miners will fight to show futuregrowth.

Left for dead andneglected, the gold miners’ stocks are the last cheap sector in theselofty bubble-valued stock markets.  Their fundamental upsideas gold mean reverts higher on speculators’ gold-futures buying and new investment demand asstock markets roll over is enormous.  This is easy to understand with a simpleexample.  In the last four quartersincluding Q3’18, the top GDX gold miners’ AISCs averaged $869.

During gold’s lastmajor upleg in essentially the first half of 2016, it powered about 30% higherdriven by surging investment demand after stock markets suffered back-to-backcorrections.  That was even small by historicalgold-bull-upleg standards.  If we merelyget another 30% gold advance from its recent mid-August low of $1174, we’relooking at $1525 gold.  That would work wonders for gold-mining profitsand stock prices.

At $1525 gold and $869AISCs, the major gold miners would be earning $656 per ounce.  That’s 96% higher than Q3’18’s $334!  If gold-mining profits double, gold-stockprices will soar.  Indeed during that last30% gold bull in the first half of 2016, GDX rocketed 151% higher!  So the gold-stock outlook is wildly bullish with gold itself dueto power higher as the stock markets roll over on the Fed’s record tightening.

While gold-stocksentiment remains overwhelmingly bearish, the major gold miners’ fundamentalsare still solid.  They are stillstruggling with flat-to-shrinking production, but their mining costs remain farbelow the prevailing gold prices.  Theyare still generating strong operating cash flows and some profits without theinevitable non-cash writedowns sparked by weaker gold prices.  OCFs and earnings will soar as gold prices recover.

So a big mean-reversionrebound higher is inevitable and imminent. While traders can play that in GDX, that is mostly a bet on the largestgold miners with slowing production.  Thebest gains by far will be won in smaller mid-tier and junior gold miners withsuperior fundamentals.  Acarefully-handpicked portfolio of elite gold and silver miners will generatemuch-greater wealth creation than ETFs dominated by underperformers.

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The bottom line is themajor gold miners’ fundamentals remain far stronger than implied by their left-for-deadstock prices.  While they are stillstruggling to grow production, they are holding the line on all-in sustainingcosts.  That fueled solid operating cashflows in Q3 despite weaker gold prices.  Boththose and GAAP profits will surge dramatically in coming quarters as gold meanreverts higher on big investment buying.

Gold stocks are notonly unloved and dirt-cheap today, but they are a rare sector that ralliesstrongly with gold as general stock markets weaken.  While virtually no one was interested inthese leveraged plays on gold upside in recent months, that will change fast asthese lofty stock markets roll over.  Andthe major gold miners’ just-finished Q3 earnings season proved they remainready to fundamentally amplify gold’s gains.

Adam Hamilton, CPA

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