The
junior gold miners’ stocks have been thrashed in August, plummeting
to brutal multi-year lows. Such carnage naturally left sentiment
far more bearish than usual in this forsaken contrarian sector. But
these extremely-battered gold-stock prices certainly aren’t
justified fundamentally. Junior gold miners’ collective results
from their just-completed Q2’18 earnings season prove their stock
prices need to mean revert way higher.
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 $4.5b
in net assets. Among all gold-stock ETFs, that was second only to
GDX’s $8.4b. 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 a couple
years ago, resulting in a stealthy 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 mid-tier gold miners, while greatly demoting true smaller
junior gold miners in terms of their ETF weightings. This
controversial move defying long decades of convention was done
quietly behind the scenes to avoid backlash.
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’ Q2’18 earnings
season in mid-August, I dug into the top 34 GDXJ components’
results. That’s simply an arbitrary number that fits neatly into
the tables below. Although GDXJ included a staggering 71 component
stocks this week, the top 34 accounted for a commanding 81.1% of its
total weighting.
Out
of these top 34 GDXJ companies, only 4 primary gold miners
met that sub-75k-ounce-per-quarter qualification to be a junior gold
miner! Their quarterly production is rendered in blue below, and
they collectively accounted for just 8.9% 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, and really
ought to be advertised as such. While its holdings include some of
the world’s best gold miners with huge upside potential, the great
majority definitely aren’t classic junior gold miners. At least
this ETF’s big composition changes are stabilizing, as Q2’18 was the
first quarter since mid-2016 where GDXJ’s components didn’t
radically change year-over-year.
I’ve
been doing these deep quarterly dives into GDXJ’s top components for
years now. In Q2’18, fully 32 of the top 34 GDXJ components were
also GDX components! These are separate and distinct ETFs, a
“Gold Miners ETF” and a “Junior Gold Miners ETF”. So they shouldn’t
have 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 32 GDX components accounted for 78.4% of GDXJ’s total
weighting, not just its top 34. They also represented 38.0% of
GDX’s total weighting. Thus nearly 4/5ths of this “Junior Gold
Miners ETF” is made up by over 3/8ths of the major “Gold Miners
ETF”! These GDXJ components also in GDX start at the 10th-highest
weighting in that latter larger ETF and extend down to 47th. GDXJ
is mostly smaller GDX stocks.
In a
welcome change from GDXJ’s vast component turmoil of recent years,
only 2 of its top 34 stocks are new since Q2’17. Their symbols are
highlighted in light blue below. Thus the top GDXJ components’
collective results are finally getting comparable again in
year-over-year terms. Analyzing ETFs is much easier if their larger
components aren’t constantly in flux. Hopefully changes going
forward are relatively minor.
Despite all this, GDXJ remains the leading “junior-gold” benchmark.
So every quarter I wade through tons of data from its top
components’ latest results, and dump it into a big spreadsheet for
analysis. The highlights make 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
others trade in Australia and the UK.
In
these countries and most of the rest of the world, regulators only
mandate that companies report their results in half-year
increments. Some do still issue quarterly production reports, but
don’t release financial statements. There are wide variations in
reporting styles, data presented, and release timing. So blank
fields in these tables mean a company hadn’t reported that
particular data for Q2’18 as of this Wednesday.
The
first couple columns of these tables show each GDXJ component’s
symbol and weighting within this ETF as of this week. While most of
these stocks trade on US exchanges, some symbols are listings from
companies’ primary foreign stock exchanges. That’s followed by each
gold miner’s Q2’18 production in ounces, which is mostly in
pure-gold terms. That excludes byproduct metals often present in
gold ore.
Those are usually 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, those GEOs
are included instead. Then production’s absolute year-over-year
change from Q2’17 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.
August’s plunge wasn’t righteous.
It
was great to see GDXJ’s top 34 components almost unchanged from
Q2’17, with only two new stocks in those ranks. My
previous essays
on GDXJ components’ quarterly results had been a sea of light blue
since 2016. But one of the new components in Q2’18 is inexplicably
the giant largely-African miner AngloGold Ashanti. It produced an
enormous 805k ounces of gold last quarter, the largest in GDXJ by
far.
Remember that major-gold-miner threshold has long been 1m+ ounces
per year. AU’s production is annualizing to over 3x that, making
this company the world’s 3rd-largest gold miner last
quarter. Why on earth would managers running a “Junior Gold Miners
ETF” even consider AngloGold Ashanti? It is as far from junior-dom
as gold miners get. Having so many of the same stocks in both GDXJ
and GDX is a big problem.
Such
massive overlap between these two ETFs is a huge lost opportunity
for VanEck. It owns and manages GDX, GDXJ, and even 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 Q2’18 production, that would run down near 127k or 92k 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 these mid-tier gold miners’ Q2’18 results, production is the best
place to start since that is the lifeblood of the entire gold-mining
industry. These top 34 GDXJ gold miners that had specifically
reported Q2 production as of the middle of this week produced 4467k
ounces. That surged a massive 24.7% YoY, implying these miners are
thriving. But that’s almost all driven by that huge 805k-ounce
boost from AU’s inclusion.
Without AngloGold Ashanti which wasn’t there in Q2’17, the rest of
the top 34 GDXJ gold miners saw their total production climb 2.2%
YoY to 3662k ounces. That’s a little behind the 3.0% annual
growth in overall global mine production in Q2’18 according to the
World Gold Council’s latest Gold Demand Trends report. But these
mid-tier miners are still faring far better than the majors that
dominate that other GDX ETF.
As
discussed last week in my essay on the
GDX gold miners’
Q2’18 results, their production adjusted for quarterly data
availability plunged a sharp 7.7% YoY! With big economically-viable
gold deposits getting increasingly hard to discover, the majors are
really struggling to replace depleting production. So much of the
growth is coming from the mid-tiers and juniors, which will help
their stock prices outperform the majors.
Starting from far-lower production bases, most of the smaller gold
miners can ramp production by adding single new mines. These are
often modest in scale and cost compared to the giant mines the
majors need to target. Since growing production greatly boosts
profits, investment capital will increasingly flow into mid-tier
gold miners in coming years. So GDXJ’s upside should well outpace
the major-dominated GDX’s.
For
all GDXJ’s faults, it does still offer investors exposure to
much-smaller gold miners. The average quarterly production of all
the top 34 GDXJ miners reporting it in Q2 was 144.1k ounces. That
is 44% smaller than the 258.3k averaged by the top 34 GDX
miners last quarter. And again AU’s crazy inclusion really skews
this. Ex-AU, the GDXJ average falls to 122.1k. That annualizes to
488k, solidly in the mid-tier realm.
With
today’s set of top-34 GDXJ gold miners achieving relatively-good
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 Q2’18, these top 34
GDXJ-component gold miners that reported cash costs averaged $631
per ounce. That was actually up a slight 0.5% YoY, contrary to what
you’d expect with higher production.
The
majority of reporting gold miners saw cash costs rise significantly
last quarter. There were plenty of challenges at various individual
mines, including unexpected downtimes and lower ore grades. Both of
those yield fewer ounces to bear the burden of gold mining’s big
fixed costs. General price inflation is also mounting thanks to the
trillions of
dollars of money central banks conjured out of thin air over the
past decade.
$631
per ounce is still very healthy, not much worse than the GDX majors’
average of $610 last quarter. That means these elite mid-tier gold
miners could temporarily weather gold prices way down into the
mid-$600s and still keep their mines running! At worst in
mid-August, gold plunged to $1174 on close driven by epic
all-time-record
gold-futures short selling. Gold had fallen 4.1% month-to-date
by that point, a big loss.
But
the GDXJ gold miners suffered disproportionally, with this ETF’s
price plummeting 15.5% MTD in sympathy with gold! That 3.8x
downside leverage was excessive, the result of irrational herd
sentiment. GDXJ’s share price was crushed to a brutal 2.4-year low,
implying these miners are in fundamental peril. But with gold still
trading a whopping 86% above their cash costs even at recent lows,
that clearly wasn’t the case.
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 them average
$886 per ounce in Q2’18. That was also up a modest 0.9% YoY, so
costs didn’t decline proportionally with rising production. Still
$886 is an excellent level compared to prevailing gold prices, and
competitive with the GDX majors which
averaged $856
last quarter. $886 is right in line with the past four quarters’
trend of $879, $877, $855, and $923 too.
The
fundamental implications of this are very bullish, proving that this
month’s gold-stock capitulation was purely an overdone
herd-sentiment thing. Gold averaged $1306 in Q2’18, up 3.9%
YoY. That means the top GDXJ gold miners were earning average
profits just under $420 per ounce. Thanks to AISCs mostly
holding the line and modestly-higher gold prices, those earnings
rose a solid 10.7% YoY from $379 in Q2’17.
With
gold mining considerably more profitable last quarter than a year
earlier, you’d think the gold-stock prices would’ve been
proportionally higher. Yet GDXJ’s average price in Q2 still slipped
1.1% lower YoY, which makes no sense fundamentally. And even if
August’s capitulation-grade $1175 gold was able to magically persist
as if those crazy-record gold-futures shorts were never covered,
gold mining is still very profitable.
At
Q2’18’s average AISCs which are again right in line with recent
years’ levels, $1175 gold would still yield hefty $289-per-ounce
profits for the mid-tier gold miners. Those don’t justify deep
multi-year lows in gold-stock prices. And these profits will
balloon dramatically as gold inevitably mean reverts much higher.
Extreme gold-futures short-covering buying is imminent, and will be
proportional to August’s record shorting.
The
impact of higher gold prices on mid-tier-gold-miner profitability is
easy to model. Assuming flat all-in sustaining costs at Q2’s $886
per ounce, 10%, 20%, and 30% gold rallies from mid-August’s lows
would lead to collective gold-mining profits surging 40%, 81%, and
122%! And another 30% gold upleg isn’t a stretch at all. In the
first half of 2016 alone after the
first
stock-market corrections in years, 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.
As
long as the gold miners can produce gold at all-in sustaining costs
way below prevailing gold prices, they will generate big profits for
investors. Eventually their stock-price levels have to reflect
their true underlying profitability. With $1175+ gold and $886
AISCs, the mid-tier gold miners’ stocks must mean revert way
higher. Their extreme low levels today are
fundamentally
absurd, they can’t and won’t last for long.
With
GDXJ’s radical composition changes finally settling down, the rest
of its top 34 components’ core fundamentals are finally
comparable year-over-year again. It’s nice to have that massive
rejiggering in GDXJ’s underlying index past us. These elite
mid-tier miners’ total revenues climbed 9.3% YoY to $5558m, well
outpacing gold’s 3.9% YoY gain. That 2.2% higher production
excluding AngloGold Ashanti also helped.
Those sales helped generate cash flows from operations of $1384m.
While 5.1% lower YoY, that is still massively positive for this
small contrarian sector. As long as gold mines are yielding far
more cash than they cost to run, the mid-tier gold miners remain
fundamentally healthy. Positive cash flows build capital necessary
to expand operations, and helped drive these miners’ cash war chests
up 9.3% YoY to $6784m in Q2.
But
their hard GAAP profits as reported to regulators collectively
looked terrible, collapsing from a strong $751m in Q2’17 to a big
$146m loss in Q2’18! Is that the fundamental monkey wrench
justifying these wretched stock-price levels? Not at all, as big
unusual items flushed through bottom lines can make profits
comparisons very misleading. There were two huge non-recurring
items that mostly drove this big swing.
A
year ago in Q2’17, elite mid-tier miner IAMGOLD reported a colossal
$524m one-time non-cash gain from the reversal of mine-impairment
charges. That accounted for nearly 70% of the top 34 GDXJ gold
miners’ overall profits that quarter! Without that unusual item,
their total Q2’17 profits were just $227m. Another unusual item
heavily skewed last quarter’s latest profits, coming from mid-tier
gold miner New Gold.
Gold
mining is very challenging and risky, with many problems not evident
until mining is well underway. New Gold’s serious troubles
illustrate why diversifying capital across multiple gold miners is
essential for all contrarian investors. NGD’s young Rainy River
gold mine isn’t living up to potential due to variability in ore
grades and processing. So in late July NGD slashed Rainy River’s
2018 production outlook by a huge 30%!
Not
only did NGD’s stock crater, but this Rainy River situation is so
bad New Gold recorded a $282m impairment charge on that mine! Such
unusual non-recurring items flow directly into profits. Without
that New Gold disaster, the top 34 GDJX gold miners’ total GAAP
earnings in Q2’18 were $136m. While still down a major 40.2% YoY,
that $91m drop is a fraction the size of the $897m including those
unusual items.
The
mid-tier gold miners’ recently-reported solid-to-strong Q2’18
results prove that their brutal plunge in August wasn’t
fundamentally righteous. Like all capitulations fueled by cascading
stop-loss selling, it was merely a sentimental and technical thing.
As gold surges on the record futures short-covering buying that is
imminent, the battered gold stocks will mean revert dramatically
higher. And the mid-tiers will lead the way.
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 really 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 that
shouldn’t be in there. They are either too large, are saddled with
inferior fundamentals, or both.
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.
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The
bottom line is the mid-tier gold miners reported solid-to-strong
fundamentals in their recent Q2’18 results. They were able to
modestly grow their production despite the majors’ falling rather
sharply. More gold mined combined with essentially-flat costs and
higher average gold prices fueled solid profits growth. The
mid-tiers’ production costs were far below prevailing gold prices
even at mid-August’s deep capitulation lows.
That
gold plunge that dragged gold stocks sharply lower was driven by
crazy-all-time-record gold-futures short selling. Those extreme
positions must soon be closed with proportional buying, which will
catapult gold sharply higher. With gold-stock prices trading at
such fundamentally-absurd levels today, they ought to soar and
really leverage gold’s coming mean-reversion gains. Their
post-capitulation upside is huge. | 
