|
The gold miners’
stocks have skyrocketed this year as investors started returning to
this long-abandoned sector. Many have tripled, quadrupled, or even
quintupled since mid-January alone! But are such epic gains
fundamentally justified? Much insight into this crucial question
for investors can be gleaned from the gold miners’ latest quarterly
financial and operational results. Their Q2 reports just finished
coming in.
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’re faring. And the just-reported second quarter of 2016 proved
an exceedingly-strong one for gold stocks. Their benchmark HUI NYSE
Arca Gold BUGS Index soared 38.4% higher in Q2 on a mere 7.4% gold
rally! Gold stocks’ 5.2x upside leverage to gold was extreme.
The gold stocks
began 2016 at
fundamentally-absurd price levels relative to gold, the
overwhelmingly-dominant driver of their profits and hence ultimately
stock prices. Coming out of mid-January’s crazy 13.5-year
secular low, the gold stocks were certainly overdue to soar in a
massive mean-reversion rally. But with the HUI skyrocketing 182.2%
at best in just 6.5 months by early August, the gains have been
huge!
So this
once-a-quarter look we get into the gold miners’ operations and thus
fundamentals is supremely important. Collectively this red-hot
sector’s Q2’16 10-Qs greatly illuminate whether or not its
blistering recent stock-price gains are fundamentally justified,
whether or not today’s far-higher gold-stock prices are sustainable,
and whether or not their powerful new bull still has legs.
Investors greatly need this insight.
The definitive
list of gold-mining stocks to analyze comes from the most-popular
gold-stock investment vehicle, the GDX VanEck Vectors Gold Miners
ETF. Its composition and performance are very similar to the
benchmark HUI.
GDX utterly dominates the gold-stock-ETF space, with no meaningful
competition. Its net assets of $10.8b are running 33.3x those of
the next-largest normal 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.
As of this week,
GDX included a whopping 49 major “gold miners”! Despite being
advertised as a “Gold Miners ETF” GDX also includes major silver
miners, silver streamers, and gold royalty companies. GDX isn’t
as pure as its name implies, but nevertheless it’s what we’ve got.
This week I dug into the 10-Qs of the top 34 GDX-component
companies, a number chosen because it fits neatly into the two
tables below.
Collectively these
34 top GDX-component stocks account for 91.9% of its total
weighting, a commanding sample. While the great majority of these
companies’ Q2’16 results were released on time, a few didn’t make
that 45-day cutoff. They are either foreign companies operating
under inferior financial-reporting standards, or companies with June
30th fiscal year-ends. Audited annual reports have 90-day filing
deadlines.
The tables below
summarize some of the key data I collected from quarterly reports
for these top 34 GDX components. If data wasn’t provided by a
particular company, I left the relevant cells blank. The tables
start with market-level information including each company’s stock
symbol, exchange traded on, current weighting in GDX, market
capitalization, and trailing-twelve-month price-to-earnings ratio.
Blank means no P/E.
That’s followed by
Q2 financial data starting with cash costs per ounce of gold mined,
all-in sustaining costs per ounce, and AISC guidance for full-year
2016. Next comes quarter-end cash balances, their percentage of
each company’s market cap, and Q2’16’s cash flows generated from
operations. That’s followed by each company’s quarterly gold
production. Silver miners’ gold-only production is listed if
reported.
Collectively these
34 elite gold miners produced 9924k ounces of gold in Q2. That
translates into 308.7 metric tons. According to the World Gold
Council’s just-released Q2’16 Gold Demand Trends report, the
definitive research on world gold supply and demand, total global
mine production ran 786.9t of gold in Q2. Thus the top 34 GDX
component companies account for nearly 4/10ths of the world’s
total, a major chunk.
I last did this
fundamental analysis of GDX’s top 34 components 3 months ago,
looking at Q1’16
data. It’s really illuminating to see trends evolve
quarter-on-quarter. Interestingly the big gold-stock gains in Q2
were not increasingly concentrated in these major gold miners
dominating GDX’s weighting. The top 34 accounted for 96.7% of its
total weight a quarter ago, but only 91.9% today. That’s likely a
bullish sign.
Broadening
participation, investment capital flowing into an increasing number
of companies, is a key hallmark of young bull markets. The great
cornucopia of bargains left in the wake of bear markets is a
target-rich environment for value investors. But later as bulls
mature and threaten to peak, the gains get concentrated in fewer and
fewer stocks. Greedy investors chase the narrowing leaders,
abandoning the rest.
GDX’s Q2’16 gain
ran 38.8%, slightly besting the HUI’s 38.4%. If you add up the
market capitalizations of these top 34 GDX components, they’re
running $217.1b now compared to $171.5b 3 months ago. While these
market caps are from about 6 weeks after quarter-ends when I do this
analysis, they rose 26.6% quarter-on-quarter. Stock-price gains
outpacing market-cap gains implies dilution isn’t yet a problem.
The gold miners
are notorious for issuing new shares to fund mine purchases from
other companies, new mine builds, and expansions of existing mines.
Since mainstreamers including bankers generally don’t like gold or
understand its potential, bank loans are often hard to come by. So
far we haven’t seen big share issuances by the gold miners despite
their sharply-higher share prices. That’s good for investors.
The gold miners’
trailing-twelve-month price-to-earnings ratios look atrocious.
They are either off-the-charts high or nonexistent due to accounting
losses over the last 4 quarters. With such terrible profits, how
can anyone argue today’s far-higher gold-stock price levels are
fundamentally justified? Investors need to understand both why the
gold miners’ P/E ratios look so ugly, and why that will soon change.
Back in the 1990s
before I founded Zeal, I worked as a Certified Public Accountant for
an elite Big-Six firm auditing mining companies. One of the core
principles we CPAs must adhere to is conservatism. That demands we
anticipate possible future losses but not gains. Gold-mining
assets have to be written down if lower gold prices impair their
value, but are not subsequently revalued higher when gold recovers.
Back in
mid-December, 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. Thus gold
miners suffered one of their
toughest quarters
ever in Q4’15. As is always the case at major bottoms, traders
overwhelmingly assumed gold would keep on spiraling lower
indefinitely. Gold-mining managers feared the same, and were forced
to act on gold’s lower prevailing prices.
Generally-accepted
accounting principles demanded they write down the carrying values
of gold mines and exploration deposits on their books. The
historical costs put into developing those assets were slashed to
much-lower values assuming $1050 gold would persist indefinitely.
The economics of gold mining are such that lower gold prices often
sharply reduce the profitability and viability of extracting
deposits.
So Q4’15 in
particular, and to a lesser extent Q3’15 leading up to it, saw
massive writedowns of gold-mining assets’ carrying values. These
flowed through the income statements as losses, even though they are
merely an accounting construct with no cash implications. A
gold mine built for $700m written down to $500m generates $200m in
accounting losses, but these are paper losses with no cash outlays
at all.
Gold miners’
price-to-earnings ratios look so outrageous today because those
non-cash writedowns due to extreme secular gold lows are still
masking rapidly-growing operating earnings as gold recovers. The
trailing-twelve-month P/E ratios extend to the past 4 quarters.
So writedowns won’t roll off the books until Q4’16 in most cases,
although some gold miners did their writedowns in mid-2015 instead
of the end.
Once these
writedowns fade into the past in the upcoming quarters, gold miners’
large and growing operating profitability will translate into big
accounting earnings. That will vastly collapse industry P/E
ratios, and expose the serious value inherent in gold stocks that’s
now obscured. Gold stocks can’t be analyzed in conventional
valuation terms until trailing-twelve-month accounting profits
actually reflect operations.
Back in Q4’15,
gold miners’ very survivability was called into question thanks to
gold’s dire secular lows. Yet they were never at risk as evidenced
by low cash costs, which are the acid test of any gold
miner’s viability. They include all cash necessary to produce each
ounce of gold, including all direct production costs, mine-level
administration, smelting, refining, transport, regulatory, royalty,
and tax expenses.
While no one is
questioning gold miners’ viability in Q2’16 with gold averaging
$1259 per ounce, cash costs are still important to consider. Among
GDX’s top 34 companies these cash costs averaged $617 per ounce in
Q2’16. That’s up 5.8% sequentially from Q1’16’s $583. But at
just under half prevailing gold levels in Q2, this industry’s
cash costs remain low and impressive. They rose for a couple
reasons.
When gold prices
are lower, mine managers often cherry pick their best ores to mine
to ensure sufficient cash flows. This includes delaying digging
through lower-grade ore to get to higher-grade ore below. But as
gold prices mean revert higher out of last year’s extreme secular
lows, that high-grading pressure abates. Mine managers can choose
ore to mine more strategically, and lower-grade ores increase costs.
Mine costs and
operational throughputs are essentially fixed. So if a mine is
processing the same rock tonnage but recovering less gold, fixed
costs are spread across fewer ounces raising cash costs. Another
factor is oil prices, which rocketed 35.5% higher from Q1 to Q2 on
an average basis. Diesel fuel is one of gold mining’s bigger
variable costs, so higher oil prices make fueling excavators and
haul trucks more expensive.
All-in sustaining
costs,
introduced by the World Gold Council in June 2013, are a
far-superior measure of gold-mining costs and therefore operating
profitability. AISC include all direct cash costs, but add on
everything necessary to maintain and replenish operations at
current levels. This includes exploration for new gold to mine,
mine-development and construction expenses, remediation, and mine
reclamation.
All-in sustaining
costs also include the critical corporate-level administration to
oversee the gold mines. This new metric is radically more important
than classic cash costs since AISC reflect the true costs of
maintaining gold mines as ongoing concerns. In Q2 these top 34 GDX
components’ average AISCs weighed in at $886 per ounce. That was up
6.4% from Q1’16’s $833, essentially the same rise as cash costs.
Gold stocks are
such a lucrative investment during gold bull markets because of
their extreme profits leverage relative to gold. For the
most part, 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 them, and how to process that ore to
recover the gold. These costs don’t change much regardless of what
gold’s price does.
At Q2’16’s average
$1259 gold price, $886 AISCs yield strong per-ounce profits of
$373. That’s not only up 6.0% from Q1’16’s $352 operating profits
despite higher costs, but 38.7% better than Q4’15’s $269
margins. Yet between Q4’15 and Q2’16, the average gold price only
climbed 14.0%. Higher gold prices translate into much-higher
profits for gold mining, making gold stocks exceedingly attractive
during gold bulls.
It’s really
impressive the elite gold miners were able to hold the line on
all-in sustaining costs in Q2’16, despite mixing in more lower-grade
ore and dealing with much-higher oil prices. As gold continues to
mean revert higher on
coming massive
investment buying, gold-mining profitability will continue to
leverage and amplify gold’s gains. That’s going to slash this
industry’s P/E ratios once writedowns roll off.
The gold miners’
outlook for full-year-2016 AISCs improved slightly in Q2 as well,
coming in at $888 per ounce which was slightly lower than Q1’s
$890. Last year’s trial by fire helped these companies figure out
how to thrive at $1050 gold, let alone Q2’s $1259 or today’s $1350
or much higher. These low costs are going to fuel much-higher
operating profitability even in the current Q3, with gold averaging
$1342 so far.
That suggests
industry Q3’16 operating profits are running about $454 per ounce,
already another 22% higher than Q2’s on a mere 6.5%
quarter-on-quarter gold rally! Investors who understand gold
miners’ amazing profits leverage to gold prices are the ones who’ve
been aggressively buying this year and are already enjoying monster
gains. By the time operations are reflected in P/Es, gold stocks
will be much higher.
One key accounting
number known with absolute certainty is cash on hand. If gold
miners are really generating big operating profits masked by last
year’s accounting writedowns, that should be evidenced in growing
cash hoards. At the end of Q2, these elite top GDX gold miners had
$12.0b in cash on hand. That was indeed up 13.2% sequentially from
Q1’s $10.6b, definitely a strong quarterly build for this industry.
With all the
short-term fictions inherent in the GAAP earnings that feed P/E
ratios, a much-better read on current profitability comes
from operating cash flows. They reveal current profitability or
lack thereof from gold-mining operations. If gold miners are truly
improving fundamentally, it must be evident in their OCFs. And
their latest quarterly results proved this is indeed the case, with
cash generated soaring in Q2.
Q2’16’s total
operating cash flows from these elite top GDX miners weighed in at a
relatively-hefty $4.1b. That’s a whopping 32.3% better than Q1’16’s
$3.1b, on that mere 6.3% increase in the average gold price! Even
with gold’s $1259 across Q2, the gold miners are already generating
major cash flows hand over fist from mining and selling their gold.
Imagine how Q3’s OCF will look with gold averaging $1342 so far.
And it’s certainly
not like $1350 gold is the end of this young new bull. Investors
today remain
radically underinvested in gold just as lofty overvalued
central-bank-goosed stock markets are overdue to roll over into
major new bears
worldwide. Gold is one of very few assets that generally moves
counter to the stock markets, making it the ideal portfolio
diversifier. Investors are going to flood back in as stock markets
turn south.
All that buying
will push gold prices much higher, as I
explained in
depth last week. Back in 2012 right before the Fed’s
unprecedented open-ended third quantitative-easing campaign
started levitating
and grossly distorting stock markets, gold averaged $1669.
Much-higher gold prices are going to lead to far-higher gold-mining
profitability, as gold-mining costs are largely fixed. That means
far-higher gold-stock prices!
Gold miners’
latest quarterly results just released for Q2 proved they are not
only fundamentally strong today, but rapidly strengthening.
This industry that was left for dead in late 2015 is going to see
the best operating-profits growth by far in all the stock markets in
2016, helping to justify the epic gains in gold-stock prices already
seen this year. They are rooted in big real operating-profits
growth, not ethereal sentiment.
As gold-stock
prices continue to rise in coming quarters, driven by soaring
profits fueled by higher gold prices, great gains are still to be
won. It won’t be benchmarks like GDX and the HUI that see the
largest gains though, but the best individual gold miners’ stocks
with superior fundamentals. These gains will be reaped by prudent
investors who do their homework, rather than settling for GDX’s
sector-average performance.
At Zeal we’ve
spent literally tens of thousands of hours researching
individual gold stocks and markets, so we can better decide what to
trade and when. This has resulted in 833 stock trades recommended
in real-time for our newsletter subscribers since 2001. Their
average annualized realized gains including all losers are running
way up at +17.6%! And that’s excluding the huge unrealized
gains on our books today.
They’re running as
high as 575% this week, with many doubles, triples, and quadruples
this year alone! We’re also starting a major new gold-stock and
silver-stock deployment to ride the coming upleg. You can read
about our new trades and market timing in our acclaimed
weekly and
monthly
newsletters. They draw on our 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.
Subscribe today!
For just $10 an issue, you can learn to think, trade, and thrive
like a contrarian.
The bottom line is
the major gold miners just reported an outstanding Q2’16. Despite
being masked by writedown-distorted P/E ratios, these companies are
enjoying major surges in operating profitability driven by the
higher prevailing gold prices. That trend has persisted strongly
into Q3, so fundamentals for the gold-mining industry are continuing
to improve dramatically. That’s why investors are flooding back in.
Gold stocks are
ready to surge again as investment demand drives gold prices
higher. The gold miners’ inherent profits leverage really amplifies
gold’s gains, and higher earnings entice in more investors leading
to higher stock prices. Gold stocks’ young new bull is just getting
started, with the biggest gains yet to come. The smart investors
will be fully deployed long before P/E ratios reflect this
industry’s turnaround.
| 
