Gold Mid-Tiers’ Q1’19 Fundamentals

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

The wild market action in 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-market stock index plunged 9.2% in December alone, nearly entering a new bear market, the leading mid-tier gold-stock ETF surged 13.7% higher that month.  That was a warning shot across the bow that these markets are changing.

Four times a year publicly-traded companies release treasure troves of valuable information in the form of quarterly reports.  Required by the US Securities and Exchange Commission, these 10-Qs and 10-Ks contain the best fundamental data available to traders.  They dispel all the sentiment distortions inevitably surrounding prevailing stock-price levels, revealing corporations’ underlying hard fundamental realities.

The global nature of the 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-different reporting requirements.  These include half-year reporting rather than quarterly, long 90-day filing deadlines after year-ends, and very-dissimilar presentations of operating and financial results.

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

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

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

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

Smaller juniors by market capitalization were abandoned entirely, cutting them off from the sizable flows of ETF capital.  Larger juniors were kept, but with their weightings within GDXJ greatly demoted.  Most of its ranks were filled with mid-tier gold 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-appreciation potential!

For years major gold miners have struggled with declining production, they can’t find or buy enough new gold to offset their depletion.  And the stock-price inertia from their large market capitalizations is hard to overcome.  The mid-tiers can and are boosting their gold output, which fuels growth in operating cash flows and profitability.  With much-lower market caps, capital inflows drive their stock prices higher much faster.

Every quarter I dive into the latest results from the top 34 GDXJ components.  That’s simply an arbitrary number that fits neatly into the tables below, but a commanding sample.  These companies represented 82.7% of GDXJ’s total 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 explorers with zero.

These majors accounted for 13.0% of GDXJ’s total weighting, and really have no place in a “Junior Gold Miners 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 just 8.9% of GDXJ’s total.  But only 4 of them at a mere 4.4% of GDXJ are true juniors, meaning they derive over half their revenues from actually mining gold.

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

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

The average Q1’19 gold production 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 common holdings, GDXJ is increasingly outperforming GDX.  GDXJ holds many of the world’s best mid-tier gold miners with big upside potential as gold’s own bull resumes powering higher.  Thus it is important to analyze GDXJ miners’ latest results.

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

18 of the GDXJ top 34 primarily trade 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 followed by each gold miner’s Q1’19 production in ounces, which is mostly in pure-gold terms excluding byproducts often found in gold ore like silver and base metals.  Then production’s absolute year-over-year change from Q1’18 is shown.

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

Percentage changes aren’t relevant or meaningful if data shifted from positive to negative or vice versa, or if derived from two negative numbers.  So in those cases I included raw underlying data rather than weird or misleading percentage changes.  In cases where foreign GDXJ components only released half-year data, I used that and split it in half where appropriate.  That offers a decent approximation of Q1’19 results.

Symbols highlighted in light blue newly climbed into the ranks of GDXJ’s top 34 over this past year.  And symbols highlighted in yellow show the rare GDXJ-top-34 components that aren’t also in GDX.  If both conditions are true blue-yellow checkerboarding is used.  Production bold-faced in blue shows the handful of junior gold miners in GDXJ’s higher ranks, under 75k ounces quarterly with over half of sales from gold.

This whole dataset together compared with past quarters offers a fantastic high-level read on how mid-tier gold miners as an industry are faring fundamentally.  While slightly-lower gold prices made Q1 somewhat challenging, the GDXJ miners generally fared quite well.  They mostly kept costs in check, paving the way for profits to soar and really amplify gold’s overdue-to-resume bull market.  That’s very bullish for their stocks.

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

Reshuffling at the top makes year-over-year changes less comparable, particularly given KGC’s larger size relative 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 is normal for companies to rise into and fall out of the top 34’s lower end.  All these year-over-year comparisons are across somewhat-different top-34 stocks.

Production has always been the lifeblood of the gold-mining industry.  Gold miners have no control over prevailing gold prices, their product sells for whatever the markets offer.  Thus growing production is the only manageable way to boost revenues, leading to amplified gains in operating cash flows and profits.  Higher production generates more capital to invest in expanding existing mines and building or buying new ones.

Gold-stock investors have long prized production growth above everything else, as it is inexorably linked to company growth and thus stock-price-appreciation potential.  The top 34 GDXJ gold miners excelled in that department, 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 GDX as well as the entire world’s gold-mining industry.

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

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

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

Their awesome Q1 production surge wasn’t just from the new components climbing into the ranks of the top 34 over this past year.  The average 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’ market capitalizations.  The GDXJ top 34 averaged just $1.7b in the middle of this week.

Last week the GDX top 34 sported a far-higher average of $5.2b.  With the mid-tiers generally less than a third as big as the majors, their stock prices have much-less inertia.  Capital inflows as gold stocks return to favor on gold rallying propel mid-tier stocks to much-higher levels faster than majors.  They truly are the sweet spot of the gold-stock realm, not bogged down like the majors with way less risk than the juniors.

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

The mid-tier gold miners 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 expanding them or building a new mine to boost their output beyond depletion.  But the majors are increasingly failing to do this from the already-high production bases they operate at.  As long as majors are struggling, it is prudent to avoid them.

GDXJ investors would be better served if this ETF contained no major 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 GDX where they belong, it would give GDXJ much-better upside potential.  That would make this ETF more popular and successful.

In gold mining, production and costs are generally inversely related.  Gold-mining costs are largely fixed quarter after quarter, with actual mining requiring about the same levels of infrastructure, equipment, and employees.  So the higher production, 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 major ways to measure gold-mining costs, classic cash costs per ounce and the superior all-in sustaining costs per ounce.  Both are useful metrics.  Cash costs are the acid test of gold-miner survivability in lower-gold-price environments, revealing the worst-case gold levels necessary to keep the mines running.  All-in sustaining costs show where gold needs to trade to maintain current mining tempos 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 Q1’19 these top-34-GDXJ-component gold miners that reported cash costs averaged $730 per ounce.  That was up a sizable 5.4% YoY, and much worse than the GDX top 34’s $616 average.

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

Two major South African miners saw really-high cash costs too, Sibanye’s eye-popping $1956 per ounce and Harmony’s $1017.  South Africa’s former gold juggernaut has been struggling for years, facing endless government corruption and very-deep and expensive mines.  Sibanye in particular really needs to get kicked out of GDXJ, as it is now a primary platinum-group-metals miner at well over 5/8ths of Q1 revenues.

Finally Hecla’s cash costs skyrocketed 54% YoY to $1277 in Q1, mainly due to ongoing problems at its Nevada operations.  It actually suspended 2019 production and cost guidance on these, which certainly isn’t a good sign!  None of these 4 gold miners represent mid-tiers as a whole.  Excluding them, the rest of the GDXJ top 34 averaged excellent cash costs of just $622 last quarter.  That’s on the low end of the range.

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 gold mines as ongoing concerns.  AISCs 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 gold miners’ true operating profitability.

The GDXJ-top-34 AISC picture in Q1’19 looked much like the cash-cost one.  Average AISCs defied much-higher production to surge 6.0% higher YoY to $1002 per ounce!  While still far below Q1’s average gold price of $1303, those were the highest AISCs seen by far since at least Q2’16 when I started this thread of research.  But again that was heavily skewed by those same 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 GDXJ top 34 averaged a far-better $891 per ounce.  That was 5.8% lower than Q1’18’s average, 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 under control.

Interestingly gold-mining costs tend to peak in Q1s before drifting lower in subsequent quarters.  That’s because gold miners often make capital improvements and sequence mining in such a way that Q1s see the lowest ore grades and thus lowest production.  I discussed this in some depth last week in my GDX Q1’19 essay.  Odds are the GDXJ mid-tiers’ costs will decline significantly in coming quarters as output ramps.

Yet even at that distorted artificially-high Q1 average AISC of $1002, the elite GDXJ gold miners have great potential to enjoy surging profits and hence stock prices as gold recovers.  The average gold price in Q1’19 drifted 1.9% lower YoY to $1303.  That implies 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 gold to $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 2016 after major stock-market selloffs, gold blasted 29.9% higher in 6.7 months!  Gold can rapidly return to favor.

At $1300 and Q1’s $1002 average AISCs, the major gold miners are still earning a very-healthy $298 per ounce.  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% gold uplegs from here!  And if the mid-tiers’ average AISCs retreat back near $900 without the outliers, that profits growth rockets 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 sector is so darned attractive.  The major gold stocks of GDX tend to amplify gold uplegs by 2x to 3x, and the mid-tier miners of GDXJ usually do much better.  As gold rallies on renewed investment demand as stock markets weaken, better mid-tier gold stocks soar dramatically multiplying investors’ wealth.  This is a must-own sector.

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

In terms of hard accounting numbers, 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 gold output 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-progress mega-merger between elite gold majors Newmont and Goldcorp.

The higher sales among the 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 problems are isolated in a handful of GDXJ components, not mid-tier miners as a whole.  The majors of GDX again fared much worse last quarter, seeing earnings fall 7.2% YoY when accounting for that mega-merger.  Mid-tiers are really outperforming.

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

The GDXJ top 34’s overall cash treasuries fell a similar 20.4% YoY in Q1 to $5.1b, reflecting lower OCFs.  But less cash isn’t necessarily negative, as gold miners tap their cash hoards when they are building or buying expansions or mines.  So declining cash balances suggest more investment to grow production in future quarters, which is always good news in this sector.  The mid-tier golds’ Q1’19 results were bullish.

GDXJ’s mostly-mid-tier component list of great gold miners is really faring well, especially compared to the struggling large gold miners.  Investors looking to ride this gold-stock bull should avoid the world’s biggest gold producers and instead deploy their capital in the mid-tier realm.  The best gains will be won in individual smaller gold miners with superior fundamentals, plenty of which are included within GDXJ.

Despite being the world’s leading gold-stock ETF, GDX needs to be avoided.  The major gold miners that dominate its weightings are struggling too much fundamentally, unable to grow their production.  Capital will instead flow into the mid-tiers, juniors, and maybe a few smaller majors still able to boost their output and thus earnings going forward.  None of this is new, but the major and mid-tier disconnect continues to worsen.

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

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

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

Adam Hamilton, CPA

May 24, 2019

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