Gold Mining Mid-Tier Stocks Fundamentals / Commodities / Gold and Silver Stocks 2019

The mid-tier goldminers’ stocks in the sweet spot for price-appreciation potential have been strugglingin recent months, grinding lower with gold. Their strong early-year momentum has been sapped by recent stock-marketeuphoria.  But gold-mining stocks aremore important than ever for prudently diversifying portfolios.  The mid-tiers’ recently-reported Q1’19results reveal their fundamentals remain sound and bullish.

The wild market actionin Q4’18 emphasized why investors shouldn’t overlook gold stocks.  All portfolios need a 10% allocation in gold and its miners’ stocks!  As the flagship S&P 500 broad-marketstock index plunged 9.2% in December alone, nearly entering a new bear market, theleading mid-tier gold-stock ETF surged 13.7% higher that month.  That was a warning shot across the bow thatthese markets are changing.

Four times a yearpublicly-traded companies release treasure troves of valuable information inthe form of quarterly reports.  Requiredby the US Securities and Exchange Commission, these 10-Qs and 10-Ks contain thebest fundamental data available to traders. They dispel all the sentiment distortions inevitably surrounding prevailingstock-price levels, revealing corporations’ underlying hard fundamentalrealities.

The global nature ofthe gold-mining industry complicates efforts to gather this important data.  Many mid-tier gold miners trade in Australia,Canada, South Africa, the United Kingdom, and other countries with quite-differentreporting requirements.  These includehalf-year reporting rather than quarterly, long 90-day filing deadlines afteryear-ends, and very-dissimilar presentations of operating and financialresults.

The definitive list of mid-tiergold miners to analyze comes from the GDXJ VanEck Vectors Junior Gold MinersETF.  Despite its misleading name, GDXJis largely dominated by mid-tier goldminers and not juniors.  GDXJ is theworld’s second-largest gold-stock ETF, with $3.6b of net assets this week.  That is only behind its big-brother GDXVanEck Vectors Gold Miners ETF that includes the major gold miners.

Major gold miners are thosethat produce over 1m ounces of gold annually. The mid-tier gold miners are smaller, producing between 300k to 1mounces each year.  Below 300k is thejunior realm.  Translated into quarterlyterms, majors mine 250k+ ounces, mid-tiers 75k to 250k, and juniors less than 75k.  GDXJ was originally launched as a real junior-gold-stockETF as its name implies, but it was forced to change its mission.

Gold stocks soared in priceand popularity in the first half of 2016, ignited by a new bull market in gold.  The metal itself awoke from deep secular lowsand surged 29.9% higher in just 6.7 months. GDXJ and GDX skyrocketed 202.5% and 151.2% higher in roughly that samespan, greatly leveraging gold’s gains. As capital flooded into GDXJ to own junior miners, this ETF riskedrunning afoul of Canadian securities laws.

Canada is the center ofthe junior-gold universe, where most juniors trade.  Once any investor including an ETF buys up a20%+ stake in a Canadian stock, it is legally deemed a takeover offer.  This may have been relevant to a single corporatebuyer amassing 20%+, but GDXJ’s legions of investors certainly weren’t tryingto take over small gold miners.  GDXJ diversified away from juniors to comply withthat archaic rule.

Smaller juniors bymarket capitalization were abandoned entirely, cutting them off from the sizableflows of ETF capital.  Larger juniorswere kept, but with their weightings within GDXJ greatly demoted.  Most of its ranks were filled with mid-tiergold miners, as well as a handful of smaller majors.  That was frustrating, but ultimately beneficial.  Mid-tier gold miners are in the sweet spot for stock-price-appreciationpotential!

For years major gold minershave struggled with decliningproduction, they can’t find or buy enough new gold to offset their depletion.  And the stock-price inertia from their largemarket capitalizations is hard to overcome. The mid-tiers can and are boosting their gold output, which fuels growthin operating cash flows and profitability. With much-lower market caps, capital inflows drive their stock priceshigher much faster.

Every quarter I diveinto the latest results from the top 34 GDXJ components.  That’s simply an arbitrary number that fitsneatly into the tables below, but a commanding sample.  These companies represented 82.7% of GDXJ’stotal weighting this week, even though it contained a whopping 72 stocks!  3 of the top 34 were majors mining 250k+ounces, 21 mid-tiers at 75k to 250k, 7 “juniors” under 75k, and 3 explorerswith zero.

These majors accountedfor 13.0% of GDXJ’s total weighting, and really have no place in a “Junior GoldMiners ETF” when they could instead be exclusively in GDX.  These mid-tiers weighed in at 57.6% of GDXJ.  The “juniors” among the top 34 represented just8.9% of GDXJ’s total.  But only 4 of themat a mere 4.4% of GDXJ are true juniors, meaning they derive over half their revenues from actuallymining gold.

The rest include aprimary silver miner, gold-royalty company, and gold streamer.  GDXJ has become a full-on mid-tier goldminers ETF, with modest major and tiny junior exposure.  Traders need to realize it is not ajunior-gold investment vehicle as advertised. GDXJ also has major overlap withGDX.  Fully 29 of these top 34 GDXJgold miners are included in GDX too, with 23 of them also among GDX’s top 34 stocks.

The GDXJ top 34accounting for 82.7% of its total weighting also represent 37.4% of GDX’s own totalweighting!  The GDXJ top 34 mostly clusteredbetween the 10th- to 40th-highest weightings in GDX.  Thus over3/4ths of GDXJ is made up by almost 3/8ths of GDX.  But GDXJ is far superior, excluding the largegold majors struggling with production growth. GDXJ gives much-higher weightings to better mid-tier miners.

The average Q1’19 goldproduction among GDXJ’s top 34 was 149k ounces, a bit over half as big as the GDX top 34’s 267k average.  Despite these two ETFs’ extensive commonholdings, GDXJ is increasinglyoutperforming GDX.  GDXJ holds manyof the world’s best mid-tier gold miners with big upside potential as gold’sown bull resumes powering higher.  Thusit is important to analyze GDXJ miners’ latest results.

So after every quarterlyearnings season I wade through all available operational and financial resultsand dump key data into a big spreadsheet for analysis.  Some highlights make it into these tables.  Any blank fields mean a company hadn’treported that data as of this Wednesday. The first couple columns show each GDXJ component’s symbol and weightingwithin this ETF as of this week.  Not all are US symbols.

18 of the GDXJ top 34 primarilytrade in the US, 5 in Australia, 8 in Canada, and 3 in the UK.  So some symbols are listings from companies’main foreign stock exchanges.  That’s followedby each gold miner’s Q1’19 production in ounces, which is mostly in pure-goldterms excluding byproducts often found in gold ore like silver and basemetals.  Then production’s absoluteyear-over-year change from Q1’18 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.  In caseswhere foreign GDXJ components only released half-year data, I used that and splitit in half where appropriate.  Thatoffers a decent approximation of Q1’19 results.

Symbols highlighted inlight blue newly climbed into the ranks of GDXJ’s top 34 over this pastyear.  And symbols highlighted in yellow showthe rare GDXJ-top-34 components that aren’t also in GDX.  If both conditions are true blue-yellowcheckerboarding is used.  Productionbold-faced in blue shows the handful of juniorgold miners in GDXJ’s higher ranks, under 75k ounces quarterly with overhalf of sales from gold.

This whole dataset togethercompared with past quarters offers a fantastic high-level read on how mid-tiergold miners as an industry are faring fundamentally.  While slightly-lower gold prices made Q1somewhat challenging, the GDXJ miners generally fared quite well.  They mostly kept costs in check, paving theway for profits to soar and really amplify gold’s overdue-to-resume bullmarket.  That’s very bullish for theirstocks.

GDXJ’s managers have continuedto fine-tune its ranks over this past year, making some good changes.  For some inexplicable reason, one of theworld’s largest gold miners AngloGold Ashanti was one of this ETF’s topholdings as discussed in Q3’18.  AU was finally kicked out and replaced with asmaller major gold miner Kinross and a mid-tier Buenaventura.  Together they now account for 12.3% of GDXJ’sweighting.

Reshuffling at the top makesyear-over-year changes less comparable, particularly given KGC’s larger sizerelative to most of the rest of GDXJ’s stocks. 4 other smaller stocks also climbed into this ETF’s top-34 ranks.  As GDXJ is largely market-cap weighted, it isnormal for companies to rise into and fall out of the top 34’s lower end.  All these year-over-year comparisons are acrosssomewhat-different top-34 stocks.

Production has alwaysbeen the lifeblood of the gold-mining industry. Gold miners have no control over prevailing gold prices, their productsells for whatever the markets offer.  Thus growing production is the only manageableway to boost revenues, leading to amplified gains in operating cash flows andprofits.  Higher production generatesmore capital to invest in expanding existing mines and building or buying newones.

Gold-stock investorshave long prized production growth above everything else, as it is inexorablylinked to company growth and thus stock-price-appreciation potential.  The top 34 GDXJ gold miners excelled in thatdepartment, growing their aggregate Q1 output by a big 15.6% YoY to 4.6m ounces! That’s impressive, trouncing both the major gold miners dominating GDXas well as the entire world’s gold-mining industry.

Last week I analyzedthe GDX majors’ Q1’19results, showing they are still struggling to replace depleting production. The GDX top 34’s total output plunged asharp 6.3% YoY to 8.8m ounces, but if adjusted for a recent in-process mega-merger thatdecline moderates to 0.2% YoY.  That’sstill much worse than the world gold-mining industry as a whole, as reflectedin the World Gold Council’s comprehensive quarterly data.

Total global gold productionin Q1’19 climbed 1.1% YoY to 27.4m ounces, which the majors still fell wellshort of.  The GDXJ mid-tiers were able toenjoy very-strong growth because this ETF isn’t burdened by the struggling majors.  Again GDXJ’s components start at the 10th-highestweighting in GDX.  The 9 above thataveraged huge Q1 production of 537k ounces, which is fully 3.6x bigger than the GDXJ-top-34 average!

The more gold minersproduce, the harder it is to even keep up with relentless depletion let alonegrow their output consistently.  Large economically-viablegold deposits are getting increasingly difficult to find and ever-more-expensiveto develop, with low-hanging fruit long since exploited.  But with much-smaller production bases, mineexpansions and new mine builds generate big output growth for mid-tier golds.

Their awesome Q1production surge wasn’t just from the new components climbing into the ranks ofthe top 34 over this past year.  Theaverage growth rate of all these companies producing weighed in at 16.1% YoY,right in line with the 15.6% total growth. The law-of-large-numbers growth limitations also apply to gold miners’ marketcapitalizations.  The GDXJ top 34averaged just $1.7b in the middle of this week.

Last week the GDX top34 sported a far-higher average of $5.2b. With the mid-tiers generally lessthan a third as big as the majors, their stock prices have much-less inertia.  Capital inflows as gold stocks return tofavor on gold rallying propel mid-tier stocks to much-higher levels faster thanmajors.  They truly are the sweet spot ofthe gold-stock realm, not bogged down like the majors with way less risk than thejuniors.

Also interesting on theGDXJ production front last quarter was silver.  This “Junior Gold Miners ETF” also includesmajor silver miners, both primary and byproduct ones.  The GDXJ top 34’s silver mined surged 13.8%higher YoY to 26.5m ounces!  For comparisonthe GDX top 34’s total reported silver output of 27.3m actually plunged 25.2%YoY.  Even mega-merger-adjusted theirsilver production still fell 8.0% YoY.

The mid-tier goldminers continue to prove all-important production growth is achievable off smaller bases. With a handful of mines or less to operate, mid-tiers can focus on expandingthem or building a new mine to boost their output beyond depletion.  But the majors are increasingly failing to dothis from the already-high production bases they operate at.  As long as majors are struggling, it isprudent to avoid them.

GDXJ investors would bebetter served if this ETF contained nomajor gold miners producing over 250k ounces a quarter on average.  They still command over 1/8th of its weighting,which could be far better reallocated in mid-tiers and juniors.  If VanEck kept the major gold miners in GDXwhere they belong, it would give GDXJ much-better upside potential.  That would make this ETF more popular and successful.

In gold mining, productionand costs are generally inversely related.  Gold-mining costs are largely fixed quarterafter quarter, with actual mining requiring about the same levels of infrastructure,equipment, and employees.  So the higherproduction, the more ounces to spread mining’s big fixed costs across.  Thus with sharply-higher YoY production in Q1’19,the GDXJ top 34 should’ve seen proportionally-lower 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 show wheregold 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-leveladministration, smelting, refining, transport, regulatory, royalty, and tax expenses.  In Q1’19 these top-34-GDXJ-component goldminers that reported cash costs averaged $730 per ounce.  That was up a sizable 5.4% YoY, and much worsethan the GDX top 34’s $616 average.

These were the highestaverage mid-tier cash costs seen in the 12 quarters I’ve been doing thisresearch, which was potentially concerning. Thankfully that was heavily skewed by some extreme outliers relative tothis sector and their own history.  Peru’sBuenaventura saw cash costs soar 33% YoY to $1049!  That was a one-off anomaly driven by thecompany halting one of its key mines in January to centralize operations.

Two major South Africanminers saw really-high cash costs too, Sibanye’s eye-popping $1956 per ounceand Harmony’s $1017.  South Africa’s formergold juggernaut has been struggling for years, facing endless government corruptionand very-deep and expensive mines. Sibanye in particular really needs to get kicked out of GDXJ, as it isnow a primary platinum-group-metals minerat well over 5/8ths of Q1 revenues.

Finally Hecla’s cashcosts skyrocketed 54% YoY to $1277 in Q1, mainly due to ongoing problems at itsNevada operations.  It actually suspended2019 production and cost guidance on these, which certainly isn’t a good sign!  None of these 4 gold miners represent mid-tiersas a whole.  Excluding them, the rest ofthe GDXJ top 34 averaged excellent cash costs of just $622 last quarter.  That’s on the low end of the range.

Way more important thancash costs are the far-superior all-in sustaining costs.  They were introduced by the World Gold Councilin June 2013 to give investors a much-better understanding of what it reallycosts 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.

The GDXJ-top-34 AISCpicture in Q1’19 looked much like the cash-cost one.  Average AISCs defied much-higher productionto surge 6.0% higher YoY to $1002 perounce!  While still far below Q1’saverage gold price of $1303, those were the highest AISCs seen by far since atleast Q2’16 when I started this thread of research.  But again that was heavily skewed by thosesame 4 gold miners struggling with sky-high costs.

Excluding BVN’s $1382,SBGL’s insane $2030, HMY’s $1286, and HL’s extreme $1760, the rest of the GDXJtop 34 averaged a far-better $891 perounce.  That was 5.8% lower than Q1’18’saverage, indeed reflecting fast-growing output. It was also right in line with the 2017-and-2018 quarterly average of$903, as well as the top 34 GDX majors’ Q1’19 average of $893.  Most mid-tier golds are keeping costs undercontrol.

Interestingly gold-miningcosts tend to peak in Q1s beforedrifting lower in subsequent quarters. That’s because gold miners often make capital improvements and sequencemining in such a way that Q1s see the lowest ore grades and thus lowestproduction.  I discussed this in somedepth last week in my GDX Q1’19essay.  Odds are the GDXJ mid-tiers’ costswill decline significantly in coming quarters as output ramps.

Yet even at that distortedartificially-high Q1 average AISC of $1002, the elite GDXJ gold miners havegreat potential to enjoy surging profits and hence stock prices as goldrecovers.  The average gold price in Q1’19drifted 1.9% lower YoY to $1303.  Thatimplies the mid-tier miners were averaging profits around $301 per ounce.  Gold is due to head far higher as these bubble-valued stock markets face an overdue bear.

That will rekindle gold investment demand like usual, those new capital inflows fueling a major gold upleg.  A mere 7.7% advance from $1300 would carry goldto $1400, and just 15.4% would hit $1500. Those are modest and easily-achievable gains by past-gold-upleg standards.  During essentially the first half of 2016after major stock-market selloffs, gold blasted 29.9% higher in 6.7 months!  Gold can rapidly return to favor.

At $1300 and Q1’s $1002average AISCs, the major gold miners are still earning a very-healthy $298 perounce.  But at $1400 and $1500 gold,those profits soar to $398 and $498. That’s 33.6% and 67.1% higher on relatively-small 7.7% and 15.4% golduplegs from here!  And if the mid-tiers’average AISCs retreat back near $900 without the outliers, that profits growthrockets to 67.8% at $1400 and 101.3% at $1500!

The gold miners’awesome inherent profits leverage to gold is why this beaten-down forsaken sectoris so darned attractive.  The major goldstocks of GDX tend to amplify gold uplegs by2x to 3x, and the mid-tier miners of GDXJ usually do much better.  As gold rallies on renewed investment demand asstock markets weaken, better mid-tier gold stocks soar dramatically multiplyinginvestors’ wealth.  This is a must-ownsector.

While investorscontinue to harbor serious apathy for gold stocks, the mid-tier miners’ costsremain well-positioned to fuel monsterprofits growth in a higher-gold-price environment.  This is a stark contrast to the rest of themarkets, where rising earnings are looking to be scarce.  Investors love higher profits, and few if anysectors will rival the gold miners’ earnings growth.  It was already underway in Q1 on higher production.

In terms of hard accountingnumbers, the GDXJ top 34’s total sales grew 5.0% YoY to $4.9b in Q1’19.  That was the result of 15.6%-higher goldoutput easily offsetting the 1.9%-lower average gold price last quarter.  Again the mid-tiers just trounced the majors,with the GDX top 34’s sales dropping a sharp 5.2% YoY when adjusted for the in-progressmega-merger between elite gold majors Newmont and Goldcorp.

The higher sales amongthe top 34 GDXJ stocks also drove impressive 22.2% YoY GAAP profits growth to a total of $197m in Q1!  That again reveals the rising-cost problemsare isolated in a handful of GDXJ components, not mid-tier miners as awhole.  The majors of GDX again faredmuch worse last quarter, seeing earnings fall 7.2% YoY when accounting for thatmega-merger.  Mid-tiers are reallyoutperforming.

The one blemish on the accountingfront was operating cash flows generated, which fell 17.7% YoY in total amongthe GDXJ-top-34-component stocks to $1.1b. There were no individual-company disasters which stood out, just weakercash flows across the board.  Still themid-tier miners were producing healthy amounts of cash as the big profits gapbetween their AISCs and prevailing gold prices last quarter implied.

The GDXJ top 34’soverall cash treasuries fell a similar 20.4% YoY in Q1 to $5.1b, reflecting lowerOCFs.  But less cash isn’t necessarilynegative, as gold miners tap their cash hoards when they are building or buyingexpansions or mines.  So declining cashbalances suggest more investment to grow production in future quarters, whichis always good news in this sector.  Themid-tier golds’ Q1’19 results were bullish.

GDXJ’s mostly-mid-tier componentlist of great gold miners is really faring well, especially compared to thestruggling large gold miners.  Investors lookingto ride this gold-stock bull should avoid the world’s biggest gold producersand instead deploy their capital in the mid-tier realm.  The best gains will be won in individual smallergold miners with superior fundamentals, plenty of which are included withinGDXJ.

Despite being the world’sleading gold-stock ETF, GDX needs to beavoided.  The major gold miners thatdominate its weightings are struggling too much fundamentally, unable to growtheir production.  Capital will instead flowinto the mid-tiers, juniors, and maybe a few smaller majors still able to boosttheir output and thus earnings going forward. None of this is new, but the major and mid-tier disconnect continues toworsen.

Again back inessentially the first half of 2016, GDXJ skyrocketed 202.5% higher on a 29.9%gold upleg in roughly the same span!  WhileGDX somewhat kept pace then at +151.2%, it is lagging GDXJ more and more as itsweightings are more concentrated in stagnant gold mega-miners.  The recent big mergers aregoing to worsen that investor-hostile trend. Investors should buy better individual gold stocks, or GDXJ.

One of my core missionsat Zeal is relentlessly studying the gold-stock world to uncover the stockswith superior fundamentals and upside potential.  The trading books in both our popular weekly and monthly newsletters arecurrently full of these better gold and silver miners.  Mostly added in recent months as gold stocks recovered from deep lows, theirprices remain relatively low with big upside potential as gold rallies!

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The bottom line is themid-tier gold miners are thriving fundamentally.  They are still rapidly growing their productionwhile majors suffer chronic output declines. Most mid-tiers are holding the line on costs, which portends strongleveraged profits growth as gold continues grinding higher on balance.  The performance gap between the smaller mid-tierand junior gold miners and larger major ones is big and still mounting.

Investors and speculatorsreally need to pay attention to this intra-sector disconnect.  Gold and its miners’ stocks should power farhigher in coming years as the lofty general stock markets roll over.  But the vast majority of the gains will beconcentrated in growing gold miners, not shrinking ones.  This means the mid-tier and junior gold minerswill far outperform the majors as gold powers higher on weaker stock markets.

Adam Hamilton, CPA

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