The
junior gold miners’ stocks suffered a serious thrashing between
mid-April and early May. Relentless heavy selling blasted many back
down near deep mid-December lows, leaving sentiment in tatters. But
traders distracted by weak technicals need to keep their eyes on the
fundamental ball. The gold juniors just finished their Q1 earnings
season, which was solid. Their low stock prices are disconnected
from reality.
Four
times a year publicly-traded companies release treasure troves of
valuable information in the form of quarterly reports. These are
generally due by 45 days after quarter-ends in the US and Canada.
They offer true and clear snapshots of what’s really going on
operationally, shattering the misconceptions bred by the
ever-shifting winds of sentiment. There’s no junior-gold-miner data
that is more highly anticipated.
Until later last year, the definitive list of elite junior gold
stocks to analyze came from the world’s most-popular
junior-gold-stock investment vehicle. The GDXJ VanEck Vectors
Junior Gold Miners ETF was born in November 2009, and is the
second-largest gold-stock ETF after its big brother GDX which tracks
the larger major gold miners. Investors love junior gold miners’
stellar potential, so GDXJ has been very popular.
Unfortunately this fame has recently created major problems severely
hobbling the usefulness of GDXJ. This sector ETF has shifted from
being beneficial for junior gold miners to outright harming them.
GDXJ is literally advertised as a “Junior Gold Miners ETF”.
Investors only buy GDXJ shares because they think this ETF gives
them direct exposure to junior gold miners’ stocks. But that’s
increasingly becoming less true.
When
capital flows into GDXJ as a proxy for owning junior gold miners,
this ETF should be shunting that buying directly into junior gold
miners’ stocks. But GDXJ is no longer fully doing that. Instead
some of these capital inflows are now stealthily diverted into
larger gold miners’ stocks, which is troubling. Investors who
actually wanted to own majors would buy GDX rather than GDXJ. This
junior ETF is failing its mission.
With
capital explicitly intended by investors to buy juniors instead
redirected into majors, the junior gold miners’ stocks are being
starved of capital inflows. Strong investment buying that
should be propelling the juniors much higher isn’t reaching them,
which is quite frankly an outrage. That’s not only hurting their
present prices, but future potential too since buying begets
buying. GDXJ is sabotaging the junior sector.
How
did GDXJ go so wrong since the middle of last year? Ironically it’s
the victim of its own success. This leading junior-gold-miners ETF
tracks an index called the MVIS Global Junior Gold Miners Index. MV
Index Solutions is the indexing arm of VanEck, and its analysts have
done a good job constructing their junior index for GDXJ to
replicate. It contains most of the world’s best junior gold miners
and explorers.
The
inclusion criteria are pretty simple. Companies need to have market
caps over $150m, which is tiny. They must have average daily
trading volume of $1m, also small. And they have to generate at
least 50% of their revenues from gold or silver mining. As of this
week, this index underlying GDXJ has 48 component companies. Many
are great choices, though some are operating at mid-tier instead of
junior scales.
Before mid-2016, GDXJ’s composition was able to track this index as
claimed. But in the first half of last year as gold surged 30%
higher in its first new bull market in years, investors flooded into
GDXJ to chase the soaring junior gold miners’ stocks. This small
ETF mirroring a small sector enjoyed massive capital inflows.
GDXJ’s net assets exploded from $1b to over $5b in that span,
exceedingly large relative to its sector!
GDXJ
attempted to shunt that capital into its underlying junior gold
stocks as normal, which is the way ETFs are supposed to work.
That’s why ETF-share buying directly bids up underlying stocks. But
GDXJ ran into multiple problems. This ETF’s footprint in some
component junior gold miners was so large that its ownership stakes
approached 20%, a threshold that must not be crossed under
Canadian securities law.
GDXJ
is dominated by Canadian companies because that’s where the great
majority of the world’s junior gold miners list and trade. This
week Canadian companies accounted for nearly 2/3rds of GDXJ’s net
assets. In Canada once any investor including an ETF goes over 20%
ownership, it is deemed to be a takeover offer which must
then be automatically extended to all remaining shareholders on the
same terms!
As a
passive investor on behalf of its shareholders, GDXJ can’t be
acquiring and running gold miners. So this leading
junior-gold-miners ETF had to simply stop investing in
Canadian juniors nearing that 20% threshold! Instead GDXJ’s
managers started diverting the torrents of capital inflows into
investments in larger gold miners that weren’t a part of its mission
or underlying index. That even included adding GDX.
Every quarter I analyze the latest results from major gold miners,
junior gold miners, and silver miners using their respective leading
ETFs’ component lists. Sometime between Q2’16 and Q3’16, GDXJ’s
managers started buying GDX shares. GDX showed up as the
third-largest component of GDXJ in both
Q3’16 and
Q4’16, so I
railed about it in both analyses. It was false advertising, GDXJ
investors wanted juniors.
GDXJ’s managers diverted capital intended for junior miners into
other much-larger gold miners. Just this week for example, after
GDX at GDXJ’s second-biggest weighting the third- and fourth-largest
are bigger mid-tier gold miners not even included in GDXJ’s
underlying index. So even right now with juniors not popular at
all, at least 1/8th of the capital flowing into GDXJ for junior
exposure isn’t going to juniors!
That
was much worse later last year, and GDXJ has other problems too. It
has struggled periodically to comply with IRS diversification
regulations in order to keep preferential tax treatment as a
regulated investment company. GDXJ’s underlying index is also what
JNUG uses, that 3x leveraged ETF on junior gold miners. So vast
quantities of GDXJ shares are often tied up as hedges underlying the
crazy-volatile JNUG.
So
GDXJ is really a mess, and is no longer the “Junior Gold Miners ETF”
investors think they are buying. GDXJ’s solution is
troubling too, although it may be the only option. It will soon
change the composition of its underlying index to include
much-larger gold miners, well into the mid-tier realm. I generally
define juniors as less than 300k ounces of annual gold production,
mid-tiers from 300k to 1m, and majors over 1m.
So
in terms of weightings, going forward GDXJ is going to be dominated
by mid-tier gold miners instead of juniors! Thus investors
who really want exposure to junior gold miners are going to have to
go back to directly buying shares in these individual companies.
That’s ultimately better, as junior gold miners with superior
fundamentals will see stock-price upside dwarfing that of the ETFs
overdiversified with laggards.
Sadly GDXJ is increasingly no longer what it advertises itself as
and what investors think it is. GDXJ will continue to contain the
world’s best juniors, but their collective weightings will be
smaller which means this ETF won’t track their prices well. GDXJ
will be more of a mid-tier gold miners ETF, with performance closer
to the major-dominated GDX. Investors looking for junior exposure
need to understand what’s happening.
I’ll
absolutely continue my quarterly studies of gold miners’ operating
fundamentals, as this knowledge is essential to fuel our own trades
outlined in our newsletters. But in future quarters I might have to
lump all the GDX and GDXJ gold miners together, and then manually
divide them out into major, mid-tier, and junior categories based on
quarterly gold production of 250k+ ounces, 75k to 250k, and
less than 75k.
But
for the just-reported Q1’17, I’m sticking with my usual approach of
looking at the top 34 “juniors” that are included in GDXJ. That
number is arbitrary, it simply fits neatly into the tables below.
Out of GDXJ’s 56 component companies this week, 8 more than its
underlying index, the top 34 command a dominant 85.6% of its total
weighting. That GDX filler is ignored, but I wrote an essay on
its miners’ Q1
results last week.
Every quarter I wade through a ton of data from these elite gold
juniors’ quarterly reports, and dump it into a big spreadsheet for
analysis. Some made it into these tables. If a field is blank, it
usually means a company didn’t report that data for Q1’17 as of this
Wednesday. Some percentage changes are also left blank if that data
went from positive to negative or vice versa. That actually
happened quite a bit in Q1.
In
these tables the first couple columns show each GDXJ component’s
symbol and weighting within this ETF as of this week. Only half
these stocks are normally listed to trade in the US. So if you
can’t find a symbol, it’s a listing from a company’s primary foreign
stock exchange usually in Canada or Australia. That’s followed by
each GDXJ component’s Q1’17 gold production in ounces, mostly 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 only included GEOs if no pure-gold
numbers were available. Financial and operational reporting varies
greatly from company to company.
That’s followed by the quarter-on-quarter change, the
absolute percentage difference between Q4’16 and Q1’17. This offers
a more-granular read on gold miners’ ongoing performance trends than
year-over-year comparisons. QoQ changes are also listed for the
rest of this data, which includes cash costs per ounce of gold
mined, all-in sustaining costs per ounce, operating cash flows
generated, and GAAP accounting profits.
After spending lots of time digesting these elite gold juniors’
latest quarterly results, it’s fully apparent their stocks’ recent
sharp selloff wasn’t fundamentally-righteous at all!
Gold-stock traders got scared because gold was sliding after
gold-futures
shorting attacks. That excessive herd fear pummeled this sector
back down to fundamentally-absurd levels relative to prevailing gold
prices, spawning incredible bargains.
![](http://www.24hgold.com/24hpmdata/articles/img/Adam Hamilton-Gold Juniors Q117 Fundamentals-2017-05-19-001.gif)
![](http://www.24hgold.com/24hpmdata/articles/img/Adam Hamilton-Gold Juniors Q117 Fundamentals-2017-05-19-002.gif)
Let’s start with the top 34 GDXJ component miners’ gold production
in Q1’17, since everything else from profits to stock prices
ultimately depend on it. These elite juniors collectively mined
2.1m ounces of gold in the first quarter. Interestingly GDXJ’s 4
largest component miners not including GDX are also top-34
components of the latter major-gold-miners ETF. This brings up
another longstanding frustration with GDXJ.
VanEck owns and manages GDX, GDXJ, and that MVIS indexing company
that decides exactly which gold stocks are included in each. With
one company in total control, GDX and GDXJ should have zero
overlap in underlying companies! GDX or GDXJ inclusion should
be mutually-exclusive based on the size of individual miners. That
would make both GDX and GDXJ much more targeted and useful for
investors.
The
top 34 GDXJ gold miners’ Q1 production actually fell a sharp 6.4%
QoQ from Q4, which seems like an ominous omen. If the leading
junior gold miners can’t grow their production, that is bearish for
their collective fundamentals. But interestingly, the world’s gold
miners have long seen sharp drops in gold production from Q4s to
Q1s. I explained the reasons why in last week’s analysis of
GDX miners’ Q1’17
results.
In a
nutshell, gold miners often choose to target lower-grade ores in
first quarters before moving back to better stuff in the second and
third quarters. Early in new years, miners have fresh capital
budgets to target expansions which often require digging through
lower-grade ores. Managements are also keen to set up scenarios
where they exceed expectations later in the years, maximizing their
stock compensation.
So
the leading GDXJ junior gold miners will likely see sharp rebounds
in their collective gold production in coming quarters this year.
That gold-mining seasonality is well-established, production sliding
in Q1s before bouncing back strongly in Q2s and Q3s. Of 27 of these
top 34 GDXJ juniors reporting production in Q1’17, fully 20 had QoQ
declines averaging 11.8%! That has major implications for
gold-mining costs.
Lower gold production directly leads to higher per-ounce mining
costs. Gold miners blast and haul big chunks of gold-bearing ore to
mills. These are essentially giant rock grinders that break ore
into smaller pieces, vastly increasing the surface area for
chemicals to later leach the gold out. Mill capacity is fixed,
with limits on ore tonnage throughput. So the same quarterly
tonnage of lower-grade ore leads to fewer ounces.
But
the costs of running mills, electricity, employees, and maintenance,
are the same regardless of how rich the ore being run though.
Lower-grade ore yields fewer ounces to spread these big fixed costs
across, jacking up per-ounce costs. So a 6% drop in quarterly gold
production should lead to a 6% rise in per-ounce costs, inversely
proportional. And that’s indeed what the top GDXJ juniors
reported in Q1.
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 Q1’17, these top 34
GDXJ-component gold miners that reported cash costs averaged $647
per ounce. That was 5.1% higher than Q4’16’s $615, actually better
than the QoQ production drop.
This
was really quite impressive, as the junior gold miners’ cash costs
were only slightly higher than the GDX majors’ $623. That’s despite
the juniors each operating fewer gold mines and thus having far less
opportunities to realize cost efficiencies. Traders must recognize
the junior gold miners are in zero fundamental peril as long as
prevailing gold prices remain well above cash costs. And $650 gold
ain’t happening!
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 gold miners’ true
operating profitability.
In
Q1’17, these top 34 GDXJ components reporting AISC averaged just
$924 per ounce. While that was up 8.1% QoQ which is roughly
inversely proportional to the production decline, it’s still way
under today’s gold prices. Despite the irrational fears plaguing
this sector, the junior gold miners are quite profitable at Q1’s
average gold price of $1220. AISC of $924 still yield solid
per-ounce profits of $296, for nice 24% margins.
Naturally Q1’s high all-in sustaining costs will mean revert lower
in coming quarters as gold production rebounds, spreading high fixed
costs across more ounces of gold. But even if $924 persisted, the
junior gold miners are still seeing much-better profitability so far
in Q2. Quarter-to-date, the average gold price of $1256 is 2.9%
higher. That implies junior gold miners’ profits are surging 12.0%
higher to $332 per ounce!
Some
of these elite gold juniors gave full-year-2017 AISC guidance, and
it averaged $879 for the 14 of these top 34 GDXJ components offering
it. Thus the gold miners themselves see lower all-in sustaining
costs going forward. And managements tend to intentionally
inflate their cost forecasts early in years, which gives them more
room to beat and exceed expectations later in years. So juniors’
AISC are heading lower.
Even
that $924 in Q1 was anomalously high, driven by a single company.
Klondex Mines reported a crazy-high AISC of $1719 per ounce!
Without that extreme outlier, these top GDXJ components’ Q1 average
would’ve been just $884. That’s right in line with the GDX majors’
$878 last quarter! KLDX is forecasting its full-year AISC at $1100,
attributing Q1’s anomaly to major development costs at one gold
mine.
With
production down it’s not surprising the top 34 GDXJ components’
aggregate cash flows generated from operations also fell. They came
in at $575m in Q1, 32.5% under Q4’s levels. But as production ramps
back up in Q2, OCF will bounce back sharply as well. As long as the
junior gold miners’ operations are able to keep producing lots more
cash than they cost to run, this sector’s fundamental outlook
remains fine.
As
the juniors’ relatively-low all-in sustaining costs compared to
prevailing gold prices imply, these miners should be quite
profitable. That indeed proved true in Q1, with these top 34 GDXJ
components reporting real hard GAAP earnings totaling $100m. That’s
a whopping 44x greater than their collective profits in Q4! Despite
all the irrational fear in junior gold stocks since mid-April, even
$1220 gold yields solid fundamentals.
If
the despised junior gold miners could fare so well in Q1’17 when
gold was relatively low, imagine how they will look as gold
continues mean
reverting higher in coming quarters. In early May many of these
stocks fell to levels near or even under where they were in
mid-December, when gold was blasted down to $1128 and everyone
assumed it was heading much lower. Even at worst in May, gold was
still $91 higher!
Make
no mistake, the junior gold miners’ stock prices today are truly
fundamentally
absurd. The sharp selloff between mid-April and early May was
based purely on excessively-bearish sentiment, high fear levels that
aren’t sustainable. Sooner or later investors will realize the
folly of fleeing this sector and flood back in with a vengeance.
That will catapult these irrationally-beaten-down junior gold miners
far higher.
Given GDXJ’s serious problems, leading to diverting far too much of
its capital into larger gold miners that definitely aren’t juniors,
you won’t find sufficient junior-gold exposure in this troubled
ETF. Instead traders should prudently deploy capital in the better
individual junior gold miners’ stocks with superior fundamentals.
Their upside is vast, and would trounce GDXJ’s even if that ETF was
still working properly.
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 Q1, this has
resulted in 928 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
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The
key to this success is staying informed and being
contrarian. That means buying low when others are afraid. So we’ve
been aggressively adding new trades in recent weeks’ selloff. An
easy way to keep abreast is through our acclaimed
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The
bottom line is the elite gold juniors’ fundamentals in just-reported
Q1’17 remained quite strong and bullish. Despite relatively-low
gold prices and the usual sharp first-quarter production drop, the
juniors’ costs stayed low enough to yield solid profitability. That
will soar as gold itself mean reverts higher, due to the junior gold
miners’ high inherent profits leverage to gold. The recent major
selloff was totally unjustified.
That
makes this battered sector a screaming buy right now fundamentally.
Exceptional junior-gold-stock bargains abound as excessive and
irrational fear still taints this small contrarian sector. But with
GDXJ’s growing diversion into larger mid-tier gold miners, it should
be totally avoided by investors really seeking junior exposure.
Directly buy the superior junior gold miners’ stocks, and watch them
soar on capital inflows. |