Gold Miners’ Q4’16 Fundamentals

The gold miners’ stocks have corrected hard in recent weeks, hammered by a gold pullback driven by soaring Fed-rate-hike odds. Like any considerable selloff, this has spawned serious bearish sentiment. But the gold miners’ underlying operating fundamentals remain quite strong, proving the recent selling was purely psychological. This sector’s just-reported fourth-quarter results are impressive, very bullish.

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

After spending decades intensely studying and actively trading this contrarian sector, there is no gold-stock data I look forward to more than their quarterly reports. They offer a true and clear snapshot of what’s really going on, shattering all the misconceptions bred by the ever-shifting winds of sentiment. If you have capital deployed in this sector but don’t watch the quarterlies, you’re shooting yourself in the foot.

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

So it takes companies more time to prepare full-year financials and then get them audited by CPAs right in the heart of their busy season. As a gold-stock trader this additional Q4 delay is irritating, since the data is getting stale by Q1’s end. But as a CPA and former Big Six auditor of mining companies, I have some understanding of just how much work goes into an SEC-mandated 10-K annual report. It is enormous!

This extended Q4-reporting window naturally delays the analysis of Q4 results. While I can start digging into the first three quarters’ results 5 or 6 weeks after those interim quarter-ends, I have to wait longer for the fiscal-year quarter-ends. Thankfully the great majority of gold miners have reported by 8 or 9 weeks, so we don’t have to wait until early Q2 to analyze Q4 results. The elite gold miners’ Q4’16 was very interesting.

The definitive list of major gold-mining stocks to analyze comes from the world’s most-popular gold-stock investment vehicle, the GDX VanEck Vectors Gold Miners ETF. Its composition and performance are similar to the benchmark HUI gold-stock index. GDX utterly dominates this sector, with no meaningful competition. This week GDX’s net assets are 53.6x larger than the next-biggest 1x-long major-gold-miners ETF!

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

This week GDX included a whopping 51 component “gold miners”! That term is used somewhat loosely, as this ETF also includes major silver miners, silver streamers, and gold royalty companies. Still, all the world’s great gold miners are GDX components. For weeks I’ve been digging into the 10-Ks of the top 34 GDX component companies, an arbitrary number chosen because it fits neatly into the tables below.

Collectively these top 34 stocks account for 90.8% of GDX’s total weighting, a commanding sample by any standard. While the large majority of these Q4’16 results have been released, a few are still coming later in March. I didn’t want to delay this important analysis for them alone. GDX also contains foreign miners from Australia, South Africa, and the UK, which report in half-year increments instead of quarterly.

I waded through all available Q4’16 results released as of this Wednesday and fed a bunch of data into a spreadsheet, some of which made it into these tables. If a field is blank, that means a company didn’t report that data for Q4. If a company’s entire line is blank, that gold miner hasn’t released Q4 results yet. But with 31 of these top 34 GDX components already releasing at least some Q4 data, there’s plenty to analyze.

The gold miners’ Q4’16 results collectively offer an amazing fundamental snapshot of this now-battered contrarian sector. They clearly reveal whether there is any fundamental justification at all for the recent sharp selloff. In less than 3 weeks since mid-February, that HUI gold-stock index has plunged 16.6% on a mere 2.5% gold drop! That’s wildly excessive and purely sentimental, as the hard fundamental data proves.

In these tables the first couple columns show each GDX component’s symbol and weighting within this ETF as of this Wednesday. While most of these gold stocks trade in the States, not all of them do. So if you can’t find a symbol here, it’s a listing from a company’s primary foreign stock exchange. Next comes each company’s Q4’16 gold production in ounces, which is mostly reported by them in pure-gold terms.

Most gold miners also produce byproduct metals like silver and copper. These are valuable, as they are sold to offset some of the considerable costs of gold mining. Some companies report their quarterly gold production including silver, a construct called gold-equivalent ounces. I included that instead if no pure-gold numbers were reported. Financial and operational reporting varies widely from company to company.

That’s followed by the quarter-on-quarter change, the absolute percentage difference between Q3’16 and Q4’16. This offers a more-granular read on companies’ performance trends than year-over-year comparisons. QoQ changes are also listed for the rest of the data, which includes cash costs per ounce of gold mined, all-in sustaining costs per ounce, operating cash flows generated, and actual accounting profits.

After spending lots of time digesting these elite gold miners’ latest quarterly reports, it is fully apparent that gold stocks’ recent sharp selloff wasn’t fundamentally righteous at all. Gold-stock traders got scared because gold was sliding on an extraordinary surge in futures-implied Fed-rate-hike odds, not because of bad data from these miners. That means this anomalous recent selloff will soon reverse with sentiment.

In most businesses, the hardest thing is actually selling the products produced. But gold miners don’t share that problem, as they can easily sell every single ounce they’re able to wrest from the bowels of the Earth. Despite the stragglers that haven’t reported Q4’16 results yet, the elite gold miners of GDX had an amazing quarter production-wise. Their collective gold mined totaled a massive 10,317k ounces.

That equals 320.9 metric tons of gold. To put this into perspective, the World Gold Council which is the definitive arbiter of global gold supply-and-demand data reported total Q4’16 mine supply of 810.9t. Thus this handful of top GDX companies is responsible for almost 40% of worldwide gold production! Much gold is produced as a byproduct at companies not specializing in this metal, making primary miners valuable.

Incredibly these top GDX components’ gold production skyrocketed 4.2% quarter-on-quarter compared to Q3’16! And that’s not including the miners that haven’t released Q4 results yet. So despite all the extreme gold carnage last quarter, these elite gold miners still had the capital to really boost production. 23 of these top 34 GDX companies had an average QoQ production jump of 14.9%, which is immensely strong.

Remember gold suffered one of its worst quarters ever in Q4’16, plunging 12.7% on extreme GLD gold-ETF-share selling by stock investors thanks to that post-election Trumphoria stock-market surge. The gold miners didn’t produce more because of gold’s fall, those mine expansions were long-planned. It takes many years and big capital investments to grow production, gold supply can’t be turned on like a spigot.

This coincidental much-higher quarterly gold production helped offset a considerable fraction of the operating impact from much-lower gold prices. After a strong Q3’16 where gold averaged $1334, it fell 8.8% to average $1218 in Q4. Incidentally so far in Q1’17, gold is averaging a nearly-identical $1215 as of the middle of this week. So last quarter’s strong gold-mining economics should apply equally well to this quarter!

Gold deposits certainly aren’t homogenous, with different areas in the same ore bodies having major variations in gold mineralization. The rates at which mines can process ore are fixed, so lower-grade or higher-grade ore directly affects quarterly production. With new mines ramping up to speed at some of these major GDX companies, odds are their increased gold production will mostly prove durable going forward.

The main reason why gold-mining profits are so highly leveraged to gold prices is mining costs are essentially fixed during mine-planning stages. No matter where prevailing gold prices are, running the actual mining operations requires largely-constant costs. Miners generally employ the same number of people, operate the same number of haul trucks and excavators, and run the same mills quarter after quarter.

So gold-mining profits, and thus potential stock prices, are determined almost solely by the difference between mining costs and current gold levels. Whenever gold stocks see a sharp selloff like in recent weeks, the resulting bearish sentiment implies this sector suffered a big fundamental impairment. But the excellent collective Q4’16 cost data of these elite GDX gold miners decisively proves this isn’t the case.

There are two major ways to measure gold-mining costs, classic cash costs per ounce and the superior all-in sustaining costs per ounce. Both are useful measures. Cash costs are the acid test of gold-miner survivability in lower-gold-price environments, showing the worst-case gold levels necessary to keep the mines running. All-in sustaining costs reveal where gold needs to trade to maintain current operations indefinitely.

Cash costs naturally encompass all cash expenses necessary to produce each ounce of gold, including all direct production costs, mine-level administration, smelting, refining, transport, regulatory, royalty, and tax expenses. In Q4’16, these top GDX-component gold miners that reported cash costs averaged just $628 per ounce. That’s a substantial 3.1% improvement from Q3, and just around half current gold levels.

15 of the 24 top GDX components reporting cash costs last quarter saw big average declines of 10.5%. That makes sense given their collective sharply-higher gold production. The more gold ounces to spread the largely-fixed mining costs across, the lower the final per-ounce number. The gold miners are in no real fundamental peril as long as gold prices remain above cash costs. And $628 gold isn’t in the cards!

Way more important than cash costs are the far-superior all-in sustaining costs. They were introduced by the World Gold Council in June 2013 to give investors a much-better understanding of what it really costs to maintain a gold mine as an ongoing concern. AISC include all direct cash costs, but then add on everything else that is necessary to maintain and replenish operations at current gold-production levels.

These additional expenses include exploration for new gold to mine to replace depleting deposits, mine-development and construction expenses, remediation, and mine reclamation. They also include the corporate-level administration expenses necessary to oversee gold mines. All-in sustaining costs are the most-important gold-mining cost metric by far for investors, revealing miners’ true operating profitability.

In Q4’16, these top 34 GDX components reporting AISC averaged a level of just $875 per ounce! So as long as gold stays above that price, these gold miners can keep operating at current production levels indefinitely. While this was up 2.4% from Q3’s $855, that quarterly increase was largely due to a single outlier. Hecla Mining finally started reporting gold AISC last quarter after bucking that trend for years.

Hecla’s $1247 AISC was the highest by far among these top-GDX-component gold miners. Without this one smaller gold miner’s maiden AISC report, the average retreats to $860 which is largely unchanged from Q3’s levels. I was kind of surprised to see AISC not fall given the higher production to spread these costs across. But that was offset by higher costs for new mine and expansion builds at some of these companies.

Given the GDX major gold miners’ $875 average all-in sustaining costs and Q4’s $1218 average gold price, gold mining was very profitable. Despite gold’s sharp plunge, that still yielded excellent average operating profits of $342 per ounce. That equates to a 28% profit margin, fat levels that most industries would kill for. Yet the flighty gold-stock traders often convince themselves gold miners are in mortal peril.

While they never are, the gold miners’ profits do suffer serious downside leverage to falling gold prices. This is the mirror image of their huge upside leverage to rising gold prices, illustrating the double-edged-sword nature of this core fundamental relationship. In Q3’16 gold averaged $1334 while GDX miners’ AISC averaged $855. That made for hefty gold-mining profits of $479 per ounce among these elite companies!

While the average gold price only fell 8.8% in Q4, the major gold miners’ per-ounce earnings plunged by 28.6%. So there was fundamental justification for the HUI’s steep 21.1% Q4 slide, given gold suffering one of its worst quarters ever. But sentiment in late Q4, like now, was far too bearish given the still-good operating profits from gold mining. Traders often wrongly extrapolate gold falling indefinitely, which can’t happen.

Assuming Q4’16’s gold-mining costs carry into Q1’17, the gold-mining industry is still thriving right now despite these sentiment-depressed gold-stock levels! Q1’s average quarter-to-date gold price of $1215 is nearly identical to Q4’s, naturally yielding nearly-identical mining profits of $340 per ounce. So the gold-stock traders should be salivating at the great buying opportunity just presented by a psychology-fueled anomaly.

And after suffering miserably in gold’s dark bear years of 2013 to 2015, these elite GDX gold miners are hellbent on keeping costs in check. 22 of these top 34 GDX gold miners have given all-in-sustaining-cost guidance for full-year 2017. And that averaged $927 per ounce, which is only about 5.9% higher than Q4’s levels. As long as gold rallies more than that this year, gold-mining profitability will improve.

After studying gold miners’ quarterly results and press releases for many years, I’ve found they tend to intentionally lowball their outlooks. They conservatively forecast lower annual gold production along with higher annual costs than they actually achieve. That is prudent expectation management, setting them up to exceed expectations later in years which drives their stock prices higher. That makes everyone happy.

So I’d be really surprised if AISC in 2017 rise materially from last year’s levels between $850 and $875. And as gold inevitably recovers majorly on the big mean-reversion buying coming from stock investors and futures speculators, gold-mining profits will explode higher. That will entice capital back into these beaten-down gold stocks, catapulting them sharply higher from here. We’re on the verge of a major new upleg.

Q4’s lower gold prices naturally hit operating cash flows, which totaled just $3199m across the 22 top GDX companies reporting them so far. That’s down 35.6% from Q3’s levels. But this decline is overstated due to the year-end financial reporting. In my Q3’16 analysis of the major gold miners’ operating results, fully 30 of these 34 companies reported cash flows generated from operations. So the Q4 sample size is too small.

That gap will close by the end of March when the stragglers report, but one way to compare things now is with reporting companies’ average OCF. That ran $145m in Q4, down just 12.1% from Q3’s $165m. That makes more sense given the increased production among these elite GDX gold miners last quarter, which helped to offset some of gold’s weakness. The gold miners’ OCF generation in Q4’16 was still quite strong.

But largely because of non-cash writedowns due to lower gold prices, the gold miners’ accounting profits didn’t fare well in Q4. Among the 20 top GDX components reporting so far, they actually totaled a loss of $592m! That compares to Q3’16’s radically-larger $707m in profits. But again those came from 27 GDX components that quarter, as the quarterly reports come out much sooner than year-ending annual reports.

Gold mining has always been highly profitable in quarters with higher prevailing gold prices, and far less profitable in other quarters where gold is lower. Given their highly-leveraged relationship with gold, this sector’s earnings can be very volatile quarter-to-quarter. But smoothed over the past year, the gold miners’ profitability rocketed higher in 2016. That’s why the HUI soared 64.0% higher last year despite Q4’s plunge!

And there’s no reason the gold miners aren’t going to enjoy another big up year in 2017. Their latest operating results proved quite strong considering the extreme gold selling in the wake of that election surprise. Gold itself still needs to mean revert dramatically higher as investors and speculators alike start to migrate back in to re-establish prudent portfolio-diversifying positions. That will lead to soaring gold-mining profits.

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

At Zeal we’ve literally spent tens of thousands of hours researching individual gold stocks and markets, so we can better decide what to trade and when. As of the end of Q4, this has resulted in 906 stock trades recommended in real-time to our newsletter subscribers since 2001. Fighting the crowd to buy low and sell high is very profitable, as all these trades averaged stellar annualized realized gains of +22.0%!

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The bottom line is the major gold miners’ fundamentals in just-reported Q4’16 remained quite strong and bullish despite gold’s sharp post-election plunge. While operating cash flows and profits suffered as expected, this industry’s critical all-in sustaining costs remained far below prevailing gold prices. That means the gold miners continue to generate big operating cash flows to expand operations and pay down debt.

And once gold itself inevitably mean reverts higher, gold-mining profits are going to soar again like they did last year. Investors and speculators alike are radically underdeployed in gold thanks to their huge Q4 selling. So gold investment demand will surge as these extreme Trumphoria-distorted stock markets roll over. That will fuel big fundamentally-justified gold-stock buying, catapulting this sector far higher.

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Adam Hamilton, CPA

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