The gold miners’
stocks have skyrocketed this year as investors started returning to
this long-abandoned sector. Many have doubled since January, with
plenty tripling or even quadrupling. Naturally such fast gains
raise concerns about whether they are actually fundamentally
justified or merely the product of fleeting sentiment that could
reverse. Gold miners’ latest quarterly results offer great
fundamental insights.
Companies trading
on the US stock markets are required by the Securities and Exchange
Commission to file quarterly earnings reports four times a year.
For normal quarters that don’t end fiscal years, these 10-Q reports
are due 45 calendar days after quarter-ends. They are a great boon
to financial-market transparency and investors seeking to understand
companies, yielding a treasure trove of information.
The gold miners
are no exception, so about 6 weeks after quarter-ends I eagerly look
forward to digging into their latest quarterly reports to see how
they are faring. I’d love to analyze these results sooner, but this
industry has always inexplicably pushed the limits of that 45-day
legal window for filing. That’s irritating in this era of
computerized accounting systems that can instantly produce real-time
data on demand.
Given the
extraordinary market events of the first quarter of 2016, it’s an
exceedingly important one to understand what’s going on with the
gold miners fundamentally. Q1’16 saw the flagship NYSE Arca
Gold BUGS Index better known by its symbol HUI blast up a staggering
60.3%! While that was driven by gold powering 16.1% higher, the
mining stocks’ 3.7x upside leverage to their metal was still quite
high.
The most-popular
gold-stock investment vehicle remains Van Eck’s GDX VanEck Vectors
Gold Miners ETF. With
a composition
very similar to that venerable benchmark HUI, GDX enjoyed one heck
of a Q1 as well with a huge 45.6% gain. This dominant gold-stock
ETF doesn’t really have any meaningful competition, with assets
running 38.2x those of the next-largest normal 1x long
major-gold-miners ETF.
Thus the gold
miners GDX’s managers include in their leading ETF are the
definitive list of this sector’s biggest and best. While
individual gold miners’ weightings in GDX are constantly tweaked,
and smaller component companies are replaced from time to time, GDX
inclusion is this industry’s gold standard. So that’s where I go
every quarter to get my population of major gold miners to analyze
their quarterly results.
As of the middle
of this week, GDX had 39 holdings. These elite gold miners are
overwhelmingly traded in the US stock markets, with 78.9% of this
ETF’s weighting. That’s followed by Australia at 11.0% and Canada
at 6.9%. I was glad to see the weighting of Chinese companies
trading in Hong Kong fall under 2.0%. Chinese financial-reporting
standards are atrocious, with muddled opaqueness defying
belief.
Before I founded
Zeal over 16 years ago, I was a certified public accountant working
at a Big Six firm auditing publicly-traded mining companies. Ever
since, I’ve been deeply immersed in researching this contrarian
sector for investment and speculation. And even with this
exceptional background, I find the Chinese quarterly reports utterly
confounding. It’s not a language thing, they intentionally obscure
key data.
But thankfully the
American, Canadian, and Australian gold miners that dominate this
industry tend to do an excellent job with their quarterly reports.
They transparently provide an abundance of key data going far beyond
legal SEC reporting requirements. That helps investors understand
what is actually going on with their companies fundamentally,
critical knowledge that is essential for success in this realm.
Every quarter I
dig through these reports and fill a spreadsheet with a wide array
of data from the results. This helps me decide which elite gold
miners I want to invest in, and equally importantly which I’d rather
avoid for a variety of reasons. These tables summarize some key
data from GDX’s top 34 holdings, or 96.7% of this leading gold-stock
ETF’s weightings. That’s how many happen to fit in our standard
chart size.
Each company’s
symbol and exchange listing purchased by GDX’s managers is followed
by its weight in that ETF, and its market capitalization as of the
middle of this week. GDX largely weights components by market cap,
which is certainly the most logical way to do it. Market cap is
actually an important thing to consider for investing, as the larger
a company is the more capital inflows it will need to propel it
higher.
That’s followed by
price-to-earnings ratios, the foundation of fundamental analysis.
Throughout all the stock markets, all stocks eventually migrate to
some reasonable multiple of their underlying companies’ corporate
profits. As I’ll discuss below, the gold miners’ P/E ratios look
absolutely abysmal today. These companies are either showing GAAP
losses or profits so trivial that they lead to ridiculously-high
P/Es.
Naturally
gold-mining profitability is purely a function of prevailing gold
prices relative to the costs of actually producing this metal. The
next few columns show the GDX miners’ cash costs per ounce and
all-in sustaining costs per ounce in Q1’16, as well as their AISC
outlooks for full-year 2016. The greater the delta between mining
costs and gold prices, the more profitable these elite gold miners
will become.
The next few
columns look at key measures of financial health including cash on
hand at the end of Q1, its percent of companies’ market
capitalizations for a relative measure, and the critical cash
generated by operations in Q1. Finally that’s followed by quarterly
production, in ounces of gold for GDX’s gold miners. If silver
miners broke out their gold separately, I included that alone. If
not, it’s Q1 silver production.
Any number under
1500k ounces is gold, anything over is silver. But obviously
silver-mining costs are excluded from the gold-mining
averages discussed in this essay. Cells are left blank where data
wasn’t available. The South African miners, for example, report in
half-year increments so there is very little if any data available
for Q1s and Q3s. The gold-mining industry actually fared very well
fundamentally in Q1’16!
Before we get to
the bullish stuff, let’s discuss the elephant under the rug.
Investors buying gold miners are generally a hardcore contrarian
lot, and that means they care deeply about valuations. But
with fully half of these elite GDX gold miners showing
trailing-twelve-month losses, and the other half sporting a crazy
average P/E of 95.6x earnings, you’d think these were technology
stocks where no one cares at all!
As discussed in
depth in my previous essay on
gold miners’
Q4’15, that bleak quarter was one of the toughest they’ve ever
witnessed. Gold averaged just $1105, which was its lowest quarterly
average since all the way back in Q4’09. And gold was crushed to a
dismal 6.1-year secular low of $1051 right after the
Fed’s first rate
hike in 9.5 years in mid-December. These lows forced
widespread asset write-downs.
One of the core
principles of accounting we CPAs must adhere to is conservatism.
We’re required to anticipate future losses but not future gains.
And with Q4’s average gold prices at 6-year lows, existing gold
mines and deposits were much less economical than at preceding
years’ higher prevailing gold prices. Some gold simply couldn’t be
mined profitably at $1100, and all the rest would be less
profitable.
So regardless of
what gold-mining executives believed about the gold-price outlook,
they were forced to take big write-downs assuming $1100-or-lower
gold was the new norm indefinitely. These losses have no cash
component whatsoever, they are truly an accounting fiction.
And once assets are written down to lower carrying values, they are
never increased again per conservatism no matter how high gold goes.
These massive
non-cash write-downs under the assumption gold would never rally
again dwarfed the
impressive operating profits the gold miners were actually
earning even in dark Q4’15. Thus this entire sector is now showing
trailing-twelve-month accounting losses or small profits after these
write-downs. But gold mining’s nonexistent and high P/E ratios mask
what is really happening on the operating front.
As these
write-downs gradually roll off of the latest four quarters’ results
used to calculate standard TTM P/E ratios, the gold miners’ P/Es
will plummet dramatically to reflect their actual costs compared
to the prevailing gold prices. I included this P/E column this week
for a reference point when that happens in the coming quarters.
Gold-stock valuations
actually fall in
gold bulls even while gold-stock prices soar!
That happens
because gold-mining costs are largely fixed during each
mine’s planning stages. That’s when mining engineers decide which
ore bodies to extract, how to dig to them, and how to process that
ore to recover the gold. So as prevailing gold prices rise, mining
costs generally don’t rise with them. That leads to expanding
profits not only greatly leveraging gold’s gains, but exceeding gold
stocks’ appreciation.
Back in Q4’15 when
gold stocks traded near
fundamentally-absurd 13-year secular lows, this industry’s very
viability and survival were widely called into question. Cash
costs are the acid test of any gold miner’s survivability. They
include all cash necessary to produce each ounce, which includes all
direct production costs, mine-level administration, smelting,
refining, transport, regulatory, royalty, and tax expenses.
In Q1’16, the
elite GDX gold miners’ average cash cost per ounce of gold was
just $583. That’s actually a slight 0.7% improvement from
Q4’15’s $587 despite higher gold prices. The gold-mining industry
as it exists today would have no problem surviving all the way down
to $600 gold! That 6-year secular low in mid-December was never a
threat, and no conceivable gold correction in the coming years will
be one either.
But cash costs
have always been problematic and misleading. It takes vast
amounts of capital to find and develop gold deposits into operating
mines, and to replace that gold as it’s naturally depleted. Cash
costs include none of these outlays absolutely critical to
gold-mining economics. Even more glaringly in some ways, they don’t
include corporate-level administration! And those upper
managers don’t come cheap.
So back in June
2013, the gold miners’ industry group the World Gold Council
introduced a far-superior measure called all-in sustaining costs.
This has universally spread in recent years, greatly accelerated by
gold’s brutal
central-bank-conjured bear market where gold-mining
sustainability became investors’ primary concern. Today the great
majority of gold miners report all-in sustaining costs, which is
very helpful.
Along with all the
direct cash costs of mining gold, all-in sustaining costs add
everything necessary to maintain and replenish operations at
current production levels. That includes costs for exploration for
new gold to mine, mine development and construction expenses,
remediation, reclamation, and of course corporate-level
administration. They reflect the true costs of maintaining an
ongoing gold-mining concern.
These elite GDX
gold miners reported average AISC in Q1’16 of just $833 per
ounce! That was also a slight 0.4% improvement from Q4’15’s
$836. Think about the implications of this important fundamental
revelation. In a quarter where the average gold price climbed 7.3%
to $1185, gold miners’ AISC were dead flat! That means their
operating profits improved dramatically in Q1, which TTM P/E
ratios don’t yet reflect.
The GDX gold
miners’ margins soared from $269 per ounce in Q4 to $352 per ounce
in Q1, large 31.1% growth on that mere 7.3% advance in prevailing
gold prices! And if Q1’s average all-in sustaining costs hold into
Q2, gold-mining profits will continue to explode. As of the middle
of this week, the gold price has averaged $1252 so far in Q2. That
implies $419 per ounce in profits, which is another 19.1%
higher.
Just like during
every past major bull market in gold, gold-mining earnings are
rocketing higher far faster than the gold price. That’s simply the
way the math always works due to the inherent profits leverage of
gold mining to higher gold prices. As gold continues its
long-overdue mean
reversion higher out of the anomalously-low central-bank
distortions of recent years, gold-mining profitability will soar
incredibly.
And P/E ratios
will absolutely reflect this once Q4’15’s big non-cash write-downs
roll off the latest four quarters’ results. Some companies’ P/E
ratios will improve even sooner than Q4’16 since they took
write-downs earlier last year instead of waiting until the end. So
gold-stock valuations based on the standard trailing-twelve-month
price-to-earnings ratios will certainly look radically better in the
coming quarters.
These elite gold
miners don’t expect their costs to rise much either, with current
average projections of $890 AISC for all of 2016. While that is
6.9% higher than Q1’s AISC, it’s not a concern. Investors have
become very cost-conscious in recent years, so managements want to
exceed their expectations on cost projections. Thus they tend to
overestimate AISC early in the year, to yield easier targets to
beat later.
Note above almost
all Q1’16 AISCs were well below 2016 projections. And the improving
gold prices finally give the miners some breathing room on the
exploration and mine-expansion fronts. Increased capital
expenditures this year will flow into all-in sustaining costs. But
that is very healthy for this industry since it replenishes the
reserves necessary to maintain and even expand current production
levels.
One more point on
future profitability. The last normal year for gold before those
wildly-unprecedented central-bank distortions between 2013 to 2015,
levitating stock
markets sapping alternative-investment demand, was 2012. That
was an unremarkable year for gold, a weaker correction/consolidation
year well under 2011’s secular-bull highs. Yet the gold price still
averaged $1669 even in that environment.
A mean reversion
back up to those 2012 levels even at $900 AISC would lead to
staggering operating profits of $769 per ounce for the elite gold
miners! That’s nearly triple what was seen in Q4. So gold-mining
earnings, which ultimately determine gold-mining stock prices, have
vast room to run before they near topping levels. Q1’16 decisively
proved the gold miners are thriving again on the fundamental
front.
That’s also
evident in these tables’ next set of columns that includes
quarterly operating cash flows for these GDX gold miners. The
majority saw their operations generate strong positive cash flows in
Q1, which is exactly what you’d expect given the growing gulf
between gold miners’ costs and prevailing gold prices. This
excellent cash generation fed the hefty cash treasuries seen at many
of the GDX components.
Back in Q4’15 with
gold near major secular lows, cash was seen as an important
survivability metric. As long as the gold miners weren’t burning
through their cash too fast, they could weather those gold lows. It
was rather ironic that the gold miners
were still
generating impressive operating cash flows even in that trough
quarter, as I pointed out a few months ago. Q1’16 has seen that
focus abruptly shift to expansion.
After years of
being forced to curtail their exploration and development budgets,
the gold miners can finally start planning to invest on these
critical fronts for future growth. Funded by the strengthening
operating cash flows they’re generating, and their large cash
hoards, these capital investments will lead to higher future
production for the gold miners. That will boost their profits and
further lower their valuations.
The last column in
these tables is quarterly production. These top 34 components of
GDX collectively mined 9717k ounces in Q1. That works out to 302.2
metric tons. According to the World Gold Council’s brand-new report
on Q1’16’s global gold supply-and-demand fundamentals just released
yesterday, the total world mine production was 734.0t last quarter.
So these elite GDX miners accounted for 41.2% of that.
That means this
latest fundamental read on the state of the gold-mining industry
is representative. With all-in sustaining costs way down near
$833 per ounce on average, the gold miners’ profits will continue to
surge as gold mean reverts higher. And even when gold corrects,
which is inevitable in any healthy ongoing bull market, gold won’t
plunge anywhere near low enough to pose any threat to their ongoing
viability.
The elite gold
miners’ excellent Q1’16 results prove that gold stocks’ massive
gains so far this year are indeed fundamentally justified to
a great extent. While gold stocks’ mighty new bull has really
outpaced earnings growth, that is a
righteous
mean-reversion thing as I’ve recently written extensively
about. The trough gold-stock prices were
fundamentally-absurd relative to prevailing gold prices, so they
couldn’t last.
With such a large
gulf already opening up between gold-mining costs on an
all-in-sustaining basis and current gold prices, investors can
safely assume this new gold-stock bull has a long ways to run yet.
It certainly won’t be a straight shot higher from here, but the
biggest gains are almost certainly still yet to come. Major gold
bulls tend to run for years, which gold miners amplify due to
their inherent profits leverage.
So investors
wanting to multiply their wealth as this young new bull matures
should take advantage of any weakness in this volatile sector to
deploy capital. GDX will perform well, but its upside potential
will be dwarfed by the best of the individual gold miners. The
largest miners dominating GDX’s weightings will see smaller gains
simply due to the inertia of their big market caps, and this ETF is
over-diversified as well.
So at Zeal we rely
on our decades of experience and ongoing deep research to deploy
into the higher-potential mid-tier and smaller gold miners. We
currently have open trades in just 5 and 8 of these top GDX
components in our acclaimed
monthly and
weekly
newsletters, along with 8 and 11 more elite gold and silver stocks
not in this list. Our unrealized gains include many doublings and
triplings in recent months!
Why not own the
fundamentally-superior gold miners instead of the entire sector
through GDX? We’ve spent 16+ years intensely studying and actively
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The bottom line is
the gold miners’ fundamentals were very strong in just-reported
Q1’16. Despite the powerful new gold bull this year, their low
all-in sustaining costs didn’t even rise. Way down at an average of
just $833 per ounce, the operating profitability of the gold-mining
industry is already surging to leverage gold’s advance. Eventually
these rapidly-rising earnings will be reflected in falling P/Es.
Gold-mining
valuations look the worst after major secular gold lows, due to the
non-cash write-downs they spawn. Then as gold shifts from bear to
bull mode, profits rise faster than stock prices on balance pushing
valuations down. This will become evident as this year’s sharp
initial mean-reversion-rebound gains moderate. The gold miners’
strong Q1’16 results prove their stocks’ big gains are fundamentally
justified.
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