The
junior gold miners have largely been shunned over the past year or
so, condemned to listlessly drift near lows. Their stock prices
have suffered serious collateral damage from stubbornly-bearish gold
sentiment. But they are faring much better under the hood than
their battered visages suggest, with their latest quarterly results
revealing strong fundamentals. Juniors are ready to soar when gold
sentiment turns.
Four
times a year publicly-traded companies release treasure troves of
valuable information in the form of quarterly reports. Companies
trading in the States are required to file 10-Qs with the US
Securities and Exchange Commission by 45 calendar days after
quarter-ends. Canadian companies have similar requirements. In
other countries with half-year reporting, many companies still
partially report quarterly.
The
definitive list of elite “junior” gold stocks to analyze comes from
the world’s most-popular junior-gold-stock investment vehicle. This
week the GDXJ VanEck Vectors Junior Gold Miners ETF reported $4.6b
in net assets. Among all gold-stock ETFs, that was second only to
GDX’s $7.6b. That is GDXJ’s big-brother ETF that includes larger
major gold miners.
GDXJ’s popularity testifies to the great allure of juniors.
Unfortunately this fame created serious problems for GDXJ over the
past couple years, resulting in a major mission change. This ETF is
quite literally the victim of its own success. GDXJ grew so large
in the first half of 2016 as gold stocks soared in a massive upleg
that it risked running afoul of Canadian securities laws. And most
of the world’s smaller gold miners and explorers trade on Canadian
stock exchanges.
Since Canada is the center of the junior-gold universe, any ETF
seeking to own this sector will have to be heavily invested there.
But once any investor including an ETF buys up a 20%+ stake in any
Canadian stock, it is legally deemed to be a takeover offer
that must be extended to all shareholders! As capital flooded into
GDXJ in 2016 to gain junior-gold exposure, its ownership in smaller
components soared near 20%.
Obviously hundreds of thousands of investors buying shares in an ETF
have no intention of taking over gold-mining companies, no matter
how big their collective stakes. That’s a totally-different
scenario than a single corporate investor buying 20%+. GDXJ’s
managers should’ve lobbied Canadian regulators and lawmakers to
exempt ETFs from that 20% takeover rule. But instead they chose
an inferior, easier fix.
Since GDXJ’s issuer controls the junior-gold-stock index underlying
its ETF, it simply chose to unilaterally redefine what junior
gold miners are. It rejiggered its index to fill GDXJ’s ranks with
larger intermediate gold miners, while greatly demoting true smaller
junior gold miners in terms of their ETF weightings. This
controversial move defying many decades of convention was done
stealthily behind the scenes to avoid outrage.
There’s no formal definition of a junior gold miner, which gives
cover to GDXJ’s managers pushing the limits. Major gold miners are
generally those that produce over 1m ounces of gold annually. For
decades juniors were considered to be sub-200k-ounce producers. So
300k ounces per year is a very-generous threshold. Anything between
300k to 1m ounces annually is in the mid-tier realm, where
GDXJ now traffics.
That
high 300k-ounce-per-year junior cutoff translates into 75k ounces
per quarter. Following the end of the gold miners’ Q1’18 earnings
season in mid-May, I dug into the top 34 GDXJ components’ results.
That’s just an arbitrary number that fits neatly into the tables
below. Although GDXJ included a staggering 73 component stocks in
mid-May, the top 34 accounted for a commanding 80.1% of its total
weighting.
Out
of these top 34 GDXJ companies, only 5 primary gold miners
met that sub-75k-ounces-per-quarter qualification to be a junior
gold miner! Their quarterly production is highlighted in blue
below, and they collectively accounted for just 10.3% of GDXJ’s
total weighting. But even that is really overstated, as 3 of these
are long-time traditional major silver miners that are increasingly
diversifying into gold in recent years.
GDXJ
is inarguably now a pure mid-tier gold-miner ETF. That would
be great if GDXJ was advertised as such. But it’s very misleading
if investors still believe this dominant “Junior Gold Miners ETF”
still gives exposure to junior gold miners. I suspect the vast
majority of GDXJ shareholders have no idea just how radically its
holdings have changed since early 2016, and how much it has strayed
from its original mission.
I’ve
been doing these deep quarterly dives into GDXJ’s top components for
years now. In Q1’18, fully 30 of the top 34 GDXJ components were
also GDX components! These ETFs are separate, a “Gold Miners
ETF” and a “Junior Gold Miners ETF”. So there’s no reason for them
to own many of the same companies. In the tables below I
highlighted the symbols of rare GDXJ components not also in GDX in
yellow.
These 30 GDX components accounted for 75.0% of GDXJ’s total
weighting, not just its top 34. They also represented 31.4% of
GDX’s total weighting. So 3/4ths of this “Junior Gold Miners
ETF” is made up of nearly a third of the major “Gold Miners ETF”!
These GDXJ components in GDX start at the 12th-highest weighting in
that latter larger ETF and extend down to 45th. Do investors know
GDXJ is mostly GDX gold stocks?
Fully 11 of GDXJ’s top 17 components weren’t even in this ETF a year
ago in Q1’17. They alone now account for 34.6% of its total
weighting. 16 of the top 34 are new, or 43.4% of the total. In the
tables below, I highlighted the symbols of companies that weren’t in
GDXJ a year ago in light blue. GDXJ has changed radically,
and analyzing its top components’ Q1’18 results largely devoid of
real juniors is frustrating.
Nevertheless, GDXJ remains the leading “junior-gold” benchmark. So
every quarter I wade through tons of data from its top components’
10-Qs or 10-Ks, and dump it into a big spreadsheet for analysis.
The highlights made it into these tables. Most of these top 34 GDXJ
gold miners trade in the US and Canada where comprehensive quarterly
reporting is required by regulators, but some trade in Australia and
the UK.
There regulators only mandate companies to report in half-year
increments. Fortunately many of those gold miners still do tend to
issue production reports without financial statements each quarter.
But there are wide variations in reporting styles, data presented,
and release timing. Blank fields in these tables mean a company
hadn’t reported that data for Q1’18 as of this Wednesday, after Q1
earnings season’s end.
The
first couple columns of these tables show each GDXJ component’s
symbol and weighting within this ETF as of mid-May. While the
majority of these stocks trade on US exchanges, many symbols are
listings from companies’ primary foreign stock exchanges. That’s
followed by each gold miner’s Q1’18 production in ounces, which is
mostly in pure-gold terms. That excludes byproduct metals often
present in gold ore.
These are mostly silver and base metals like copper, which are
valuable. They are sold to offset some of the considerable costs of
gold mining, lowering per-ounce costs and thus raising overall
profitability. In cases where companies didn’t separate out gold
and lumped all production into gold-equivalent ounces, these GEOs
are included instead. Then production’s absolute year-over-year
change from Q1’17 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, sales, 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. This whole
dataset together offers a fantastic high-level read on how the
mid-tier gold miners are faring fundamentally as an industry. And
that was really well in Q1’18!
Once
again the light-blue-highlighted symbols are new top-34 GDXJ
components that weren’t included a year ago in Q1’17. And the few
yellow-highlighted symbols are the only stocks that were not also
GDX components in mid-May. Despite still being advertised as a
“Junior Gold Miners ETF”, in reality GDXJ is now a mid-tier gold
miners ETF. That’s fine if investors realize this, but misleading
if they’re unaware.
Having such massive overlap between GDXJ and GDX is a huge lost
opportunity for VanEck. It owns and manages GDX, GDXJ, and the MVIS
indexing company that decides exactly which gold stocks are included
in each. With one company in total control, there’s no need for any
overlap in the underlying companies of what should be two
very-different gold-stock ETFs. Inclusion ought to be
mutually-exclusive.
VanEck could greatly increase the utility of its gold-stock ETFs and
thus their ultimate success by starting with one big combined list
of the world’s better gold miners. Then it could take the top 20 or
25 in terms of annual gold production and assign them to GDX. Based
on Q1’18 production, that would run down near 129k to 89k ounces per
quarter. Then the next-largest 30 or 40 gold miners could be
assigned to GDXJ.
Getting smaller gold miners back into GDXJ would be a huge boon for
the junior-gold-mining industry. Most investors naturally assume
this “Junior Gold Miners ETF” owns junior gold miners, which is
where they are trying to allocate their capital. But since most of
GDXJ’s funds are instead diverted into much-larger mid-tiers and
even some majors, the juniors are effectively being starved
of capital intended for them.
That’s one of the big reasons smaller gold miners’ stock prices are
so darned low. They aren’t getting enough capital inflows from
gold-stock-ETF investing. So their share prices aren’t bid higher.
They rely on issuing shares to finance their exploration projects
and mine builds. But when their stock prices are down in the dumps,
that is heavily dilutive. So GDXJ is strangling the very industry
its investors want to own!
Back
to Q1’18 results, production is the best place to start since that’s
the heart of the whole gold-mining industry. These top 34 GDXJ gold
miners collectively produced 3986k ounces of gold last quarter,
which rocketed 90.2% higher YoY! But because of GDXJ’s huge
component changes over the past year, this comparison is
meaningless. Thankfully Q1’18 should be the last quarter straddling
this epic discontinuity.
It
was the second quarter of 2017 when GDXJ’s constituency list was
radically altered to look much more like today’s. Many smaller
gold-mining stocks were demoted or booted to make way for the parade
of much-larger imports from GDX. So when this current quarter’s
results are released this summer, GDXJ’s year-over-year comparisons
should be back on apples-to-apples footing. That will be nice after
a year of turmoil.
For
all GDXJ’s faults, it does still offer investors exposure to
much-smaller gold miners. Last week I did a similar analysis with
the top GDX
components’ Q1’18 results. Their quarterly production averaged
279k ounces, well into major territory above 1m annually. But the
top 34 GDXJ miners’ comparable number was 121k ounces, which is
about 57% smaller. This is solidly into the mid-tier realm, a
different focus than GDX.
This
current list of GDXJ’s top miners are actually growing their gold
production nicely, with an average gain of 7.7% YoY. That is about
double the 3.8% of GDX’s top miners in Q1. It’s much easier to grow
off smaller bases. Generally the smaller the gold miners in
market-capitalization and production terms, and the faster they are
growing, the more stock-price appreciation potential they have when
sentiment is favorable.
With
today’s set of top-34 GDXJ gold miners achieving such impressive
production growth, their costs per ounce should’ve declined
proportionally. Higher production yields more gold to spread
mining’s big fixed costs across. And lower per-ounce costs
naturally lead to higher profits. So production growth is
highly sought after by gold-stock investors, with companies able to
achieve it commanding premium prices.
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 Q1’18, these top 34
GDXJ-component gold miners that reported cash costs averaged $692
per ounce. That surged a sharp 7.0% YoY, not what you’d expect
given the higher gold production.
But
these cash costs were skewed way higher by major South African gold
miners that should never have been included in GDXJ. They are all
way too big, and that country is suffering a nightmare scenario with
an openly-racist government trying to steal all ownership away from
anyone without black skin. So all the once-proud South African gold
miners have serious problems on multiple fronts that look
insurmountable.
Due
to technical challenges of very-deep mining and endless labor
unrest, production is sliding at the big South African miners. That
helped catapult cash costs at Sibanye Gold and Harmony Gold to
truly-crazy levels of $1155 and $1215 per ounce in Q1! Excluding
just these two outliers, the rest of these top 34 GDXJ miners had
cash costs averaging $650. That’s up just 0.5% YoY and better than
top GDX miners’ $667.
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.
These top 34 GDXJ gold miners reporting AISCs saw their average slip
0.1% lower YoY to $923 per ounce in Q1’18. These dead-flat
levels are very interesting considering the radically-different GDXJ
component list over the past year. That also compares favorably
with the GDX majors which have much-better economies of scale with
more gold mines. Their
AISCs averaged
$884 in Q1, only 4.2% lower.
And
again those big South African gold miners skewed average GDXJ AISCs
higher. While Harmony didn’t report AISCs, Sibanye’s surged to a
scary $1336 per ounce! Cut that out, and the rest of these top 34
GDXJ gold miners’ average AISCs retreat to $904. Gold miners
generally have higher costs in Q1s too, as that’s when mine
managers often choose to process lower-grade ores which retards gold
production.
Ores
within gold deposits were certainly not created equal. Miners have
to dig through lower-grade ores on the way to higher-grade stuff.
Regardless of how much gold in the rock processed, the throughput of
mines is fixed. Their mills can only process the same tonnages of
rock quarter after quarter. So when lower-grade ore is sequenced,
less gold is produced. The big fixed costs of mining are spread
across fewer ounces.
Gold
miners game their ore grades, tending to collectively have
the lowest
production and thus highest costs in Q1s and the opposite in
Q4s. These top GDXJ components’ total gold production fell 4.9% QoQ
from Q4’17! I suspect the reason mine managers choose to process
lower-grade ores early on in new years and higher-grade ores later
is to maximize their year-end stock-price appreciation and hence
bonuses!
The
mid-tier gold miners’ still-low costs last quarter prove they are
faring far better fundamentally today than their low stock prices
imply. All-in sustaining costs are effectively this industry’s
breakeven level. As long as gold stays above $923 per ounce, it
remains profitable to mine. At Q1’18’s average gold price of $1329,
these top GDXJ gold miners were still actually earning big average
profits of $406 per ounce.
That’s up an impressive 37.2% YoY, as the top 34 GDXJ gold miners in
Q1’17 had average AISCs of $924 in a lower-gold-price environment
averaging $1220. Given such major earnings growth, investment
capital should be flooding into the mid-tier gold miners. Yet
inexplicably GDXJ’s average share price of $32.82 in Q1’18 was
12.4% lower than Q1’17’s $37.46! Today’s gold-stock levels are
fundamentally-absurd.
Gold
miners offer such compelling investment opportunities because of
their inherent profits leverage to gold. Gold-mining costs
are largely fixed during mine-planning stages, when engineers and
geologists decide which ore to mine, how to dig to it, and how to
process it. The actual mining generally requires the same levels of
infrastructure, equipment, and employees quarter after quarter
regardless of gold prices.
With
gold-mining costs essentially fixed, higher or lower gold prices
flow directly through to the bottom line in amplified fashion. This
really happened in GDXJ over the past year despite its radical
changes in composition. An 8.9% gold rally in quarterly-average
terms catapulted operating profits 37.2% higher, or 4.2x. That’s
even better than the typical leverage of gold-mining profits to gold
prices of several times or so.
The
mid-tier gold miners’ stocks can’t trade as if their profits don’t
matter forever, so an enormous mean-reversion rally higher is
inevitable sooner or later. And that assumes gold prices merely
hold steady, which is unlikely.
Radical gold
underinvestment reigns today after years of extreme central-bank
easing. As major central banks start unwinding their epic QE,
stock markets
will sell off and investors will return to gold.
The
impact of higher gold prices on mid-tier-gold-miner profitability is
easy to model. Assuming flat all-in sustaining costs at Q1’18’s
$923 per ounce, 10%, 20%, and 30% gold rallies from this week’s
levels would lead to collective gold-mining profits surging 23%,
55%, and 87%! And another 30% gold upleg isn’t a stretch at all.
In the first half of 2016 alone after the previous stock-market
correction, gold soared 29.9%.
GDXJ
skyrocketed 202.5% higher in 7.0 months in largely that same
span! Gold-mining profits and thus gold-stock prices surge
dramatically when gold is powering higher. Years of neglect from
investors have forced the gold miners to get lean and efficient,
which will really amplify their fundamental upside during the next
major gold upleg. The investors and speculators who buy in early
and cheap could earn fortunes.
Given the radical changes in GDXJ’s composition over the past year,
normal year-over-year comparisons in key financial results simply
aren’t meaningful. Again the massive rejiggering of the index
underlying GDXJ didn’t happen until Q2’17, so Q1’18 is the last
quarter before results finally grow comparable. But in the
meantime, here’s the apples-to-oranges reads on the top 34 GDXJ
components’ key financial results.
Cash
flows generated from operations soared 134.0% YoY to $1367m. As
long as OCFs stay massively positive, the gold mines are generating
more cash than they cost to run. That gives the gold miners the
capital necessary to expand existing operations and buy new deposits
and mines. It is shocking that an industry so cash-flow-positive is
plagued by such ridiculously-irrational bearish sentiment, that
can’t last.
On
the hard-profits front under the Generally Accepted Accounting
Principles required by the SEC, these top 34 GDXJ gold miners earned
$161m in Q1’18. That was up 42.3% YoY, from a very-different list
of top GDXJ components. That would look far better if it wasn’t for
Yamana Gold, which alone lost $161m in Q1 from a big non-cash
impairment charge on a smaller gold miner it bought. That was the
only big GDXJ loss.
Revenues surged 80.4% YoY to $4320m, and cash on balance sheets
climbed 25.2% to $6390m. There isn’t much analysis to do with such
radically-different GDXJ constituent lists, so I can’t wait for
Q2’18 when comparable results return. But the mid-tier gold miners
were faring quite well fundamentally last quarter despite
their silly bargain-basement stock prices. This anomaly has to be
resolved to the upside.
The
mid-tier gold miners’ Q1’18 results proved again that gold stocks’
vexing
consolidation since early 2017 isn’t the result of operational
struggles, but merely bearish psychology. That will soon
shift as these
wildly-overvalued stock markets inevitably roll over, leading to
surging gold investment demand. These elite mid-tier gold miners’
stocks are a
coiled spring overdue to soar dramatically, with vast upside
potential.
While GDXJ should certainly no longer be advertised as a “Junior
Gold Miners ETF”, it offers exposure to some of the best mid-tier
gold miners on the planet. It’s growing on me, I like this new GDXJ
way better than GDX. That being said, GDXJ is still burdened by
overdiversification and way too many gold miners with inferior
fundamentals that shouldn’t be in there. They include those
struggling big South African miners.
So
the best way to play the gold miners’ coming massive mean-reversion
bull is in individual stocks with superior fundamentals.
Their gains will ultimately trounce the major ETFs like GDXJ and
GDX. There’s no doubt carefully-handpicked portfolios of elite gold
and silver miners will generate much-greater wealth creation.
GDXJ’s component list is a great starting point, but pruning it way
down offers far-bigger upside.
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 983 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 +20.2%!
The key to this
success is staying informed and being contrarian. That means buying
low before others figure it out, before undervalued gold stocks soar
much higher. An easy way to keep abreast is through our acclaimed
weekly and
monthly
newsletters. They draw on my vast experience, knowledge, wisdom,
and ongoing research to explain what’s going on in the markets, why,
and how to trade them with specific stocks. This weekend only we
are running a 20%-off sale on term subscriptions, cutting the
price as low as $9 per issue.
Subscribe today
while gold stocks remain dirt-cheap!
The
bottom line is the mid-tier gold miners now dominating GDXJ enjoyed
strong fundamentals in their recently-reported Q1 results. While
GDXJ’s radical composition changes since last year muddy annual
comparisons, today’s components mined lots more gold at dead-flat
costs. These miners continued to earn fat operating profits while
generating strong cash flows. Sooner or later stock prices must
reflect fundamentals.
As
gold itself continues mean reverting higher, these mid-tier gold
miners will see their profits soar due to their big inherent
leverage to gold. GDXJ now offers excellent exposure to mid-tier
gold miners, which will see gains well outpacing the majors. All it
will take to ignite gold stocks’ overdue mean-reversion rally is
gold investment demand returning. The resulting higher gold prices
will attract investors back to gold miners. | 
