The junior gold
miners and explorers have soared dramatically in an amazing year,
before falling hard this week. This sharp correction is doing its
job in rebalancing bull-market sentiment, crushing greed and leaving
traders wary of this sector. But gold juniors’ recently-released
second-quarter financial and operational results prove their
fundamentals are strengthening dramatically, a very bullish omen for
stock prices.
The junior gold
stocks are rightfully considered the Wild West of the gold sector.
Most of the hundreds and hundreds of these small companies won’t
prove successful. They won’t be able to secure funding to explore
sufficiently, won’t be fortunate enough to find an economic deposit
of gold to mine, or won’t be able to make the herculean leap from
explorer to miner. The odds are stacked heavily against the gold
juniors.
Nevertheless, the
elite small gold explorers and miners able to overcome and grow
their businesses to larger scales will see truly-enormous
stock-price gains. The gold juniors are exceedingly important for
the entire gold-mining industry, since they feed the critical
gold-supply pipeline with new deposits and mines to offset the
inexorable industry-wide depletion of current operations. Success
here is radically rewarded.
Many of the
world’s best junior gold miners and explorers are included in the
GDXJ VanEck Vectors Junior Gold Miners ETF, this sector’s leading
benchmark. GDXJ began trading in November 2009, and is the world’s
second-largest gold-stock ETF after its big brother GDX which tracks
larger gold miners. As of the middle of this week, GDXJ’s net
assets ran about half of GDX’s. This testifies to junior golds’
popularity.
And it’s easy to
understand why in 2016. Between gold stocks’
fundamentally-absurd 13.5-year secular lows in mid-January and
last week, GDXJ blasted 202.5% higher in just 7.0 months! While I
don’t have universal ETF data, I’d be shocked if any other sizable
ETF in all the markets even came remotely close. For comparison,
over essentially that same span GDX “only” soared 151.2%. The
juniors’ gains have been epic.
But in the single
trading week since GDXJ’s dazzling new bull high, this ETF has
plunged 14.6% as of this Wednesday which is the data cutoff for this
essay. Seeing over 1/7th of the value of even these elite juniors
included in GDXJ lopped off in a handful of trading days has really
unsettled investors. But it certainly shouldn’t have. Gold stocks
are a volatile sector, where sharp bull-market corrections
are common.
This important
sentiment-rebalancing phenomenon necessary to ensure healthy and
long-lasting bull markets last happened in May, which wasn’t too
long ago. GDXJ dropped 14.6% in a month, which also served to
eradicate greed while breeding serious pessimism. Yet out of those
very lows, GDXJ would surge another 57.2% higher by mid-August.
That bucked gold stocks’
summer-doldrums
downside risks.
Now normally
during major mid-bull corrections, investors assume selloffs
driven purely by sentiment must be fundamentally justified. If
the junior golds are falling, surely it’s because their costs are
rising and operating profits are falling. But that’s rarely true.
Corrections are triggered when greed grows too excessive. That
enthusiasm sucks in all near-term buyers leaving only sellers,
spawning sharp selloffs.
With this newest
correction underway, we have the great benefit of the junior gold
miners and explorers just finishing reporting their Q2’16 results.
Companies trading in the US and Canada are required by their
securities regulators to file quarterly reports four times a year.
These reports are generally due 45 calendar days after quarter-ends,
meaning mid-August. So the latest junior-gold fundamentals are just
available.
This week I dug
through the new second-quarter reports for GDXJ’s top 34 component
companies. That arbitrary number happens to fit neatly into the
tables below. While GDXJ held a whopping 47 different stocks as of
the middle of this week, the top 34 account for a commanding 93.1%
of its total weighting. They include many of the best junior gold
miners and explorers in the business, a great cross section.
Each quarter I
look at these companies’ 10-Qs filed with the SEC, or the
equivalents for Canadian and Australian companies. I feed a bunch
of data into a spreadsheet to help me better understand how the
individual companies and junior golds as a whole are faring. The
tables below summarize some of the key data, and prove that gold
juniors’ fundamentals are strong and improving rapidly. This
is very bullish.
The initial
columns show each top GDXJ component’s stock symbol, its exchange
traded on, its current weighting within GDXJ, and its market
capitalization. GDXJ is generally market-capitalization weighted,
which is the most logical way to construct ETFs for any sector.
That’s followed by trailing-twelve-month price-to-earnings ratios,
which are left blank when companies are still operating at an
accounting loss.
Next comes the
junior gold miners’ costs, the dominant factor affecting their
profitability. Both the cash costs per ounce and all-in sustaining
costs per ounce are included, along with the full-year-2016
projections for AISC if provided. Then comes cash on hand at the
end of Q2’16, its percentage of each GDXJ component’s market
capitalization, and the cash flows generated from operations in the
second quarter.
Finally each
company’s quarterly gold production is included. Somewhat oddly,
GDXJ’s managers have chosen to include plenty of the
large silver
miners in their “Junior Gold Miners ETF”. With so many gold
juniors to choose from, this dilution of focus seems unnecessary.
So for the large silver miners in GDXJ, I listed their gold-only
production whenever provided. No production means a company is
an explorer.
Despite this past
week’s sharp bull-market correction, the junior gold stocks are
thriving fundamentally. Their costs are stable or improving,
while their operating cash flows are soaring. Investors who loved
the junior golds a couple weeks ago ought to be scrambling to buy
aggressively now that their stocks are considerably cheaper. Their
rapidly-improving fundamentals reveal nothing at all to be concerned
about.
GDXJ’s component
list remains very similar to that seen 3 months ago when I was
analyzing this ETF’s top components’
Q1’16 results.
Most of the same companies are still included, although their
relative rankings have naturally shifted with their market
capitalizations. The elite juniors enjoying the biggest market-cap
increases, and hence stock-price gains, have seen the largest
weighting increases in GDXJ.
This sector’s
trailing-twelve-month price-to-earnings ratios are terrible, making
junior golds look wildly overvalued from a classic valuation
perspective. Most of these companies have lost money during the
past year in accounting terms, and thus have no P/Es. And most of
the junior golds that have managed to earn profits have very-high
P/E ratios. This apparently-dismal earnings situation is scaring
investors away.
The reason these
trailing-twelve-month P/Es look so ugly is the gold-mining industry
was forced to make big non-cash writedowns late last year.
Gold sinking to dismal 6.1-year secular lows impaired the value of
gold deposits and mines. Accounting rules then forced company
managers to assume gold’s deep lows would persist indefinitely. So
Q4’15 in particular saw massive writedowns of gold-mining assets.
Even though these
are essentially an accounting fiction, non-cash expenses flushing
once-capitalized historic costs out of balance sheets and through
income statements, they affect GAAP profits. So until last year’s
big writedowns slide out of the latest four quarters’ results, P/E
ratios will look ridiculous. The strong operating profitability of
gold miners won’t become apparent until Q4’16’s results,
collapsing P/E ratios.
If you want more
depth on the accounting issues skewing gold stocks’ P/E ratios to
scary extremes, last week in my
Q2’16 analysis
of the larger gold miners of GDX I discussed it deeper. Today’s P/E
ratios simply don’t reflect the radical fundamental improvements in
gold miners’ operations as 2016 marches on. They will eventually,
but for now investors have to look deeper to understand how gold
miners are faring.
That starts with
the junior golds’ cash costs per ounce. With the magnitude of this
GDXJ selloff over the past week, you’d think low-$1300s gold is a
major threat to the juniors. Nothing could be farther from the
truth! Cash costs are the acid test of gold miners’
viability, what it actually costs to wrest each ounce of gold from
the bowels of the earth. Gold miners face no existential peril as
long as gold prices exceed cash costs.
Cash costs include
all direct production costs, mine-level administration, smelting,
refining, transport, regulatory, royalty, and tax expenses. In
Q2’16, the top junior gold miners included in GDXJ averaged cash
costs of just $636 per ounce. That is actually 2.8% lower
than Q1’16’s $654, showing that the gold juniors are still improving
the efficiency of their mining operations despite this year’s higher
gold prices.
But cash costs are
misleading, as they don’t include the full costs necessary to
maintain an ongoing gold-mining operation. As gold deposits
inexorably deplete, new ones must be found and developed to
replenish current production levels. So in June 2013, the World
Gold Council introduced a far-superior gold-mining cost measure
called all-in sustaining costs. This is rightfully usurping
cash costs’ long reign.
AISC include all
direct cash costs, corporate-level administration to oversee gold
mines, exploration for new gold to mine, mine-development and
construction expenses, remediation, and mine reclamation following
economic depletion. They are what it really costs per ounce to keep
a gold-mining business humming along at current output levels
indefinitely. And the gold juniors’ AISC remain outstanding!
In Q2’16, these
elite GDXJ components reported gold all-in sustaining costs
averaging a level of $887. That’s a slight 0.7% improvement
from Q1’16’s $893. Again the junior gold miners are wringing out
new operational efficiencies even while higher gold prices are
removing the pressure to do so. Even more impressively, GDXJ
components’ average AISC are identical to
GDX components’
average of $886 in Q2’16!
The large gold
miners enjoy considerable economies of scale compared to the
juniors. Companies that manage multiple mines save on relative
administration and procurement expenses compared to smaller ones
operating single or fewer mines. So it’s pretty darned impressive
that the junior golds reported the same all-in-sustaining-cost
structure in Q2’16 as the majors! That’s an incredible show of
fundamental strength.
The junior golds’
AISC compared to average prevailing gold levels reveal their true
operating profitability that is masked by their writedown-distorted
trailing-twelve-month P/E ratios. Back in Q1’16 as gold was
emerging from last year’s brutal
rate-hike-fear-driven secular lows, this metal averaged $1185.
At the gold juniors’ Q1’16 average AISC of $893, those gold levels
yielded operating profits of $292 per ounce.
Now that’s not bad
at all considering investors were wrongly convinced the junior golds
were doomed back in mid-January. During Q2’16 the average gold
price climbed 6.3% to $1259. Thus at their latest industry-wide
AISC read of $887 per ounce in that same quarter, operating profits
blasted 27.5% higher quarter-on-quarter to $372 per ounce! 28%
profits growth on a 6% gold rally is certainly very impressive.
This great
profits leverage to gold inherent in the junior gold miners is
the dominant reason why they’re so attractive to smart investors.
Profits ultimately drive stock prices, and gold-mining profits
rocket higher on relatively-modest gold-price increases. With gold
itself in a major
new bull market, the massive surge in gold-mining profits that’s
going to generate will be breathtaking. We’re already seeing that
continue in Q3’16.
So far this
quarter, gold has averaged $1341 which is another 6.5% gain
sequentially. Meanwhile the elite GDXJ gold miners projected
full-year-2016 all-in sustaining costs averaging $883 per ounce.
That is also incidentally better than the major miners of GDX which
are forecasting $888. That means GDXJ’s junior miners are likely
earning $458 per ounce in operating profits so far in Q3’16,
another 23.1% QoQ jump!
At best
year-to-date, GDXJ soared 169.1% higher by mid-August. These epic
gains were a combination of a mean reversion higher out of
fantastically-bearish sentiment, and greatly-improving
fundamentals. Back in that
dark trough
quarter of Q4’15, GDXJ’s junior gold miners were earning $293
per ounce with AISC of $812 and gold averaging $1105. In just
two quarters, these operating margins surged 27.3% higher!
And that’s just
the beginning. Gold mines enjoy such great profits leverage to gold
because mine 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 simply don’t change much regardless of what
gold’s price does. So higher gold translates into far-higher
profits.
The best proxy of
actual profitability of current operations comes from the cash flows
generated by these very operations. In Q2’16, these elite juniors
of GDXJ earned collective operating cash flows of $949m. That was a
staggering 51.1% higher quarter-on-quarter compared to
Q1’16’s $628m! That trounces the 32.3% improvement over that same
span seen by GDX’s major gold miners. The juniors are killing it.
That hard data
alone, operating cash flows rocketing 50%+ higher in a single
quarter, provides all the fundamental justification junior golds
need for their far-higher stock prices. And that’s only going to
keep improving. Gold itself continues to mean revert out of
extremely-oversold levels from late last year. As recently as 2012
before the Fed’s
gross market distortions, gold averaged a normal $1669 per
ounce.
While gold will
head a lot higher in this young new bull as today’s lofty stock
markets artificially goosed to
near-bubble
valuations by central banks inevitably roll over into major new
bears, consider that very-conservative 2012 example. A $1669 gold
price is only another third higher than Q2’16’s average
level. Yet at current all-in sustaining costs it would catapult
gold-mining profitability 110% higher to $782 per ounce!
With Q2’16’s
massive leap in operating cash flows, the cash hoards of these elite
GDXJ gold juniors should have exploded proportionally. Yet they
didn’t, only climbing 4.1% QoQ to $4571m. The reason is very
bullish. The cash-flow statements from these gold juniors showed
many are spending big on mine expansions or new-mine builds.
These will eventually boost their production and thus future
profitability.
One example is
Pretium Resources, the largest explorer included in GDXJ under its
symbol PVG. This company is constructing an amazing new gold mine
in northern British Columbia. This $697m project is fully-funded,
set to go live less than a year from now. Pretium’s cash balance
fell 22% from $367m at the end of Q1’16 to $287m at the end of Q2’16
because it invested $155m in its new mine build in H1’16!
Pretium certainly
isn’t the only elite junior gold miner or explorer making big
investments in growing their future production. It’s really
exciting to see the junior-gold industry hit the ground running
following that existential scare late last year and early this
year. Investors would be richly rewarded if the elite junior golds
merely reaped gold’s coming bull-market gains at current production
levels. Higher ones amplify gains.
I’ve been studying
and trading gold stocks for over two decades now, and each quarter I
wade through their operating results. And the transformation this
left-for-dead sector underwent operationally in Q2’16 simply due to
higher prevailing gold prices was amazing. If a mere 6%ish gold
rally can so greatly boost the junior golds’ operating profits and
cash flows, imagine what the rest of this young new gold bull will
do.
So if you liked
the junior golds a couple weeks ago when they were still climbing,
you should love them today at correction discounts. The best
times to add new positions within ongoing bull markets are after
significant selloffs, not near preceding highs when excitement
abounds. Investors looking to ride the epic coming profits growth
in the junior golds can certainly take a stake in GDXJ, their
benchmark ETF.
But GDXJ has
serious issues that will retard its ultimate gains. In addition to
its heavy silver focus due to the high weightings of major silver
miners in this “Junior Gold Miners ETF”, it is way
over-diversified. Too many holdings dilute the massive gains
coming from the best individual gold juniors commanding superior
fundamentals. So why not jettison the deadweight within GDXJ and
just own the best of its stocks?
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The bottom line is
the gold juniors just reported an amazing Q2’16. The
modestly-higher average gold prices fueled huge gains in cash-flow
generation and operating profitability. Many junior gold miners are
plowing these soaring surpluses into expanding their existing
operations, ultimately leading to even higher production and greater
future profitability. The junior golds’ fundamentals are
dramatically improving.
Unfortunately most
investors aren’t yet aware of this hyper-bullish transformation
underway. This year’s massive surge in operating profitability is
being masked by writedown-distorted P/E ratios. And this past
week’s sharp gold-stock correction has ramped up fear again scaring
investors away. For those smart enough to overcome herd sentiment
and study the junior golds’ fundamentals, their stocks are really on
sale.
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