The
junior gold miners’ stocks have spent months grinding sideways near
lows, sapping confidence and breeding widespread bearishness. The
entire precious-metals sector has been left for dead, eclipsed by
the dazzling Trumphoria stock-market rally. But traders need to
keep their eyes on the fundamental ball so herd sentiment doesn’t
mislead them. The juniors recently reported Q3 earnings, and
enjoyed strong results.
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 used to
come from the world’s most-popular junior-gold-stock investment
vehicle. This week the GDXJ VanEck Vectors Junior Gold Miners ETF
reported $4.4b in net assets. Among all gold-stock ETFs, that was
only second to GDX’s $8.1b. 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 has recently created major problems severely
hobbling the usefulness of GDXJ. This sector ETF has shifted from
being beneficial for junior gold miners to outright harming them.
GDXJ is literally advertised as a “Junior Gold Miners ETF”.
Investors only buy GDXJ shares because they think this ETF gives
them direct exposure to junior gold miners’ stocks. But
unfortunately that’s no longer true!
GDXJ
is quite literally the victim of its own success. This ETF 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 law. Most
of the world’s junior gold miners and explorers trade in Canada. In
that country once any investor including an ETF goes over 20%
ownership in any stock, it is deemed a takeover offer that
must be extended to all shareholders!
Understanding what happened in GDXJ is exceedingly important for
junior-gold-stock investors, and I explained it in depth in my past
essay on juniors’
Q1’17 results. GDXJ’s managers were forced to reduce their
stakes in leading Canadian juniors. So capital that GDXJ investors
intended to deploy in junior gold miners was instead diverted into
much-larger gold miners. GDXJ’s effective mission stealthily
changed.
Not
many are more deeply immersed in the gold-stock sector than me, as
I’ve spent decades studying, trading, and writing about this
contrarian realm. These huge GDXJ changes weren’t advertised, and
it took even me months to put the pieces together to understand what
was happening. GDXJ’s managers may have had little choice, but
their major direction change has been devastating to true junior
gold miners.
Investors naturally pour capital into GDXJ, the “Junior Gold Miners
ETF”, expecting to own junior gold miners. But instead of
buying junior gold miners’ shares and bidding up their prices, GDXJ
is instead shunting those critical inflows to the much-larger
mid-tier and even major gold miners. That left the junior gold
miners starved of capital, as their share prices they rely heavily
upon for financing languished in neglect.
GDXJ’s managers should’ve lobbied Canadian regulators and lawmakers
to exempt ETFs from that 20% takeover rule. Hundreds of
thousands of investors buying an ETF obviously have no intention of
taking over gold-mining companies! And higher junior-gold-stock
prices boost the Canadian economy, helping these miners create
valuable high-paying jobs. But GDXJ’s managers instead skated
perilously close to fraud.
This
year they rejiggered their own index underlying GDXJ, greatly
demoting most of the junior gold miners! Investors buying GDXJ
today are getting very-low junior-gold-miner exposure, which makes
the name of this ETF a deliberate deception. I’ve championed
GDXJ for years, it is a great idea. But in its current sorry state,
I wouldn’t touch it with a ten-foot pole. It is no longer anything
close to a junior-gold-miners ETF.
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
years 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’ Q3 earnings
season in mid-November, I dug into the top 34 GDXJ components.
That’s just an arbitrary number that fits neatly into the tables
below. While GDXJ included a staggering 73 component stocks in
mid-November, the top 34 accounted for a commanding 81.1% 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 7.1% of GDXJ’s total
weighting. But even that isn’t righteous, as these include a
126-year-old silver miner and a mid-tier gold miner suffering
temporary production declines.
GDXJ
is inarguably now a pure mid-tier gold-miner ETF. That’s
great if GDXJ is advertised as such, but terrible if capital
investors explicitly intend for junior gold miners is instead being
diverted into mid-tiers without their knowledge or consent. The
vast majority of GDXJ shareholders have no idea how radically this
ETF has changed since early 2016. It is all but unrecognizable,
straying greatly from its original mission.
I’ve
been doing these deep quarterly dives into GDXJ’s top components for
years now. In Q3’17, fully 32 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 why on earth should they
own many of the same companies? In the tables below I highlighted
the rare GDXJ components not also in GDX in yellow in the weightings
column.
These 32 GDX components accounted for 78.7% of GDXJ’s total
weighting, not just its top 34. They also represented 31.4% of
GDX’s total weighting. So almost 4/5ths of the junior gold
miners’ ETF is made up of nearly a third of the major gold miners’
ETF! I’ve talked with many GDXJ investors over the years, and have
never heard one wish their capital allocated specifically to junior
golds would instead go to much-larger miners.
Fully 10 of GDXJ’s top 17 components weren’t even in this ETF a year
ago in Q3’16. They alone now account for 34.5% of its total
weighting. 16 of the top 34 are new, or 44.4% of the total. In the
tables below, I highlighted the symbols of companies that weren’t in
GDXJ a year ago in light blue. Today’s GDXJ is a radical departure
from last year. Analyzing Q3’17 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, and dump it into a big spreadsheet for analysis. The
highlights made it into these tables. A blank field means a company
didn’t report that data for Q3’17 as of that mid-November 10-Q
deadline. Companies have wide variations in reporting styles, data
presented, and report timing.
In
these tables the first couple columns show each GDXJ component’s
symbol and weighting within this ETF as of mid-November. While most
of these gold stocks trade in the States, not all of them do. So if
you can’t find one of these symbols, it’s a listing from a company’s
primary foreign stock exchange. That’s followed by each company’s
Q3’17 gold production in ounces, which is mostly reported in
pure-gold terms.
Many
gold miners also produce byproduct metals like silver and copper.
These are valuable, as they are sold to offset some of the
considerable costs of gold mining. Some companies report their
quarterly gold production including silver, a construct called
gold-equivalent ounces. I only included GEOs if no pure-gold
numbers were reported. That’s followed by production’s absolute
year-over-year change from Q3’16.
Next
comes the most-important fundamental data for gold miners, cash
costs and all-in sustaining costs per ounce mined. The latter
determines their profitability and hence ultimately stock prices.
Those are also followed by YoY changes. Finally the YoY changes in
cash flows generated from operations, GAAP profits, revenues, and
cash on balance sheets are listed. There’s one key exception to
these YoY changes.
Percentage changes aren’t relevant or meaningful if data shifted
from negative to positive or vice versa. Plenty of GDXJ gold miners
that earned profits in Q3’16 suffered net losses in Q3’17. So in
cases where data crossed that zero line, I included the raw numbers
instead. This whole dataset offers a fantastic high-level
fundamental read on how the mid-tier gold miners are faring
today, and they’re actually doing quite well.
After spending days digesting these GDXJ gold miners’ latest
quarterly reports, it’s fully apparent their vexing consolidation
this year isn’t fundamentally righteous at all! Traders have
abandoned this sector since the election because the allure of the
levitating general stock markets has eclipsed gold. That has left
gold stocks exceedingly undervalued, truly the best fundamental
bargains out there in all the stock markets!
Once
again the light-blue-highlighted symbols are new GDXJ components
that weren’t included a year ago in Q3’16. And the meager
yellow-highlighted weightings are the only stocks that were not also
GDX components in mid-November! GDXJ is increasingly a GDX clone
that offers little if any real exposure to true gold juniors’ epic
upside potential during gold bulls. GDXJ has become a shadow of its
former self.
VanEck 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, GDX and GDXJ should have zero
overlap in underlying companies! GDX or GDXJ inclusion should
be mutually-exclusive based on the size of individual miners. That
would make both GDX and GDXJ much more targeted and useful for
investors.
Two
of GDXJ’s heaviest-weighted component choices are mystifying.
Sibanye Gold and Gold Fields are major South African gold
miners, way bigger than mid-tier status and about as far from
junior-dom as you can get. In Q3’17 they both mined way in excess
of that 250k-ounce quarterly threshold that is definitely major
status. They are among the world’s largest gold miners, so it’s
ludicrous to have them in a juniors ETF.
Since gold miners are in the business of wresting gold from the
bowels of the Earth, production is the best place to start. These
top 34 GDXJ gold miners collectively produced 4352k ounces in
Q3’17. That rocketed 121% higher YoY, but that comparison is
meaningless given the radical changes in this ETF’s composition
since Q3’16. On the bright side, GDXJ’s miners do still remain
significantly smaller than GDX’s.
GDX’s top 34 components, fully 20 of which are also top-34 GDXJ
components, collectively produced 9947k ounces of gold in Q3. So
GDXJ components’ average quarterly gold production of 136k ounces
excluding explorers was 55% lower than GDX components’ 301k
average. In spite of GDXJ’s very-misleading “Junior” name, it
definitely has smaller gold miners even if they’re well above that
75k junior threshold.
Despite GDXJ’s top 34 components looking way different from a year
ago, these current gold miners are faring well on the crucial
production front. Fully 22 of these mid-tier gold miners enjoyed
big average YoY production growth of 18%! Overall average growth
excluding explorers was 8.2% YoY, which is far better than world
mine production which slumped 1.3% lower YoY in Q3’17 according to
the World Gold Council.
These elite GDXJ mid-tier gold miners are really thriving, with
production growth way outpacing their industry. That will richly
reward investors as sentiment normalizes. Smaller mid-tier gold
miners able to grow production are the sweet spot for
stock-price upside potential. With market capitalizations much
lower than major gold miners, investment capital inflows are
relatively larger which bids up stock prices faster.
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 Q3’17, these top-34
GDXJ-component gold miners that reported cash costs averaged just
$612 per ounce. That indeed plunged a major 6.9% YoY from
Q3’16, and even 2.5% QoQ from Q2’17.
This
was really quite impressive, as the mid-tier gold miners’ cash costs
were only a little higher than the
GDX majors’
$591. That’s despite the mid-tiers each operating fewer gold mines
and thus having fewer opportunities to realize cost efficiencies.
Traders must recognize these mid-sized gold miners are in zero
fundamental peril as long as prevailing gold prices remain well
above cash costs. And $612 gold ain’t happening!
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 a gold mine as an ongoing concern. AISC
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.
In
Q3’17, these top 34 GDXJ components reporting AISC averaged just
$877 per ounce. That’s down a sharp 3.7% YoY and 0.2% QoQ.
That also compares very favorably with the GDX majors, which saw
nearly-identical
average AISC at $868 in Q3. The mid-tier gold miners’ low costs
prove they are faring far better fundamentally today than traders
think based on this year’s vexing sideways-grinding stock-price
action.
All-in sustaining costs are effectively this industry’s breakeven
level. As long as gold stays above $877 per ounce, it remains
profitable to mine. At Q3’s average gold price of $1279, these top
GDXJ gold miners were earning big average profits of $402 per ounce
last quarter! That equates to hefty profit margins of 31%, levels
most industries would kill for. The mid-tier gold miners aren’t
getting credit for that today.
Unfortunately given its largely-junior-less composition, GDXJ
remains the leading benchmark for junior gold miners. In Q3’17,
GDXJ averaged $33.81 per share. That was down a serious 28.6% from
Q3’16’s average of $47.38. Investors have largely abandoned gold
miners because they are captivated by the extreme Trumphoria
stock-market rally since the election. Yet gold-mining profits
certainly didn’t justify this.
A
year ago in Q3’16, the top 34 GDXJ components at that time reported
average all-in sustaining costs of $911 per ounce. With gold
averaging $1334 then which was 4.4% higher, that implies the
mid-tier gold miners were running operating profits of $423 per
ounce. Thus Q3’17’s $402 merely slumped 5.0% YoY, which definitely
isn’t worthy of hammering mid-tier gold miners’ stock prices over a
quarter lower over the past year.
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. That
wasn’t really apparent in GDXJ over this past year since its
composition changed so radically. Normally a 4.2% drop in average
gold prices would lead to much more than a 5.0% YoY operating-profit
decline. Gold-stock profits generally leverage gold price moves
by several times.
Gold
itself is overdue for a major new upleg driven by investment
demand returning. As I discussed several weeks ago,
investment demand
has stalled thanks to the extreme stock-market euphoria. These
bubble-valued
stock markets are due to roll over imminently as the Fed and
European Central Bank both start aggressively choking off
liquidity. That will
strangle this
stock bull, reigniting big gold investment demand.
The
impact of higher gold prices on mid-tier-gold-miner profitability is
easy to model. Assuming flat all-in sustaining costs at Q3’17’s
$877 per ounce, 10%, 20%, and 30% gold rallies from this week’s
levels will lead to collective gold-mining profits surging 36%, 68%,
and 100%! And another 30% gold upleg isn’t a stretch at all. In
essentially the first half of 2016 alone after the last
stock-market correction, gold surged 29.9%.
The
major gold stocks as measured by the HUI, which
closely mirrors
GDX, skyrocketed 182.2% higher in roughly that same span!
Gold-mining profits and thus gold-stock prices soar when gold is
powering higher. So if you believe gold is heading higher in coming
quarters as these crazy stock markets falter, the gold stocks are
screaming buys today fundamentally. That’s especially true of
the best mid-tier gold miners.
Since today’s bastardized GDXJ mostly devoid of juniors changed so
radically since last year, the normal year-over-year comparisons in
key financial results aren’t comparable. But here they are for
reference. These top 34 GDXJ companies’ cashflows generated from
operations soared 65% YoY to $1515m. That was driven by sales up
96% YoY to $4130m. That left miners’ collective cash balances $28%
higher YoY at $5672m.
Yet
top-34-GDXJ-component profits crumbled 38% YoY to $212m. Again
don’t read too much into this since it’s an apples-to-oranges
comparison. Interestingly a single company that was in GDXJ in both
quarters is responsible for over 2/3rds of that drop. Endeavour
Mining’s earnings plunged from +$24m a year ago to -$65m in Q3’17,
largely due to a $54m impairment charge in its Nzema mine which is
being sold.
GDXJ’s component list was much more consistent between Q2’17 and
Q3’17. QoQ these top 34 GDXJ gold miners saw operating cash flows
rise 3.9%, sales surge 7.5%, cash on hand fall 7.6%, and profits
plummet 72%. Again an anomaly in a single company is responsible
for nearly 9/10ths of this sequential decline. In Q2 IAMGOLD
reported a gigantic $524m non-cash gain on the reversal of an
impairment charge!
The
massive non-cash gains and losses flushed through net income
are one reason why all-in sustaining costs offer a better read on
gold-miner health. If GDXJ’s component list and weightings finally
stabilize after this past year’s extreme tumult, we’ll have clean
comps again next year. For now these mid-tier gold miners are
generally doing far better operationally than their neglected
super-low stock prices imply.
So
overall the mid-tier gold miners’ fundamentals looked quite
impressive in Q3’17, a stark contrast to the miserable sentiment
plaguing this sector. Gold stocks’ vexing consolidation this year
wasn’t the result of operational struggles, but purely bearish
psychology. That will soon shift as the stock markets roll over
and gold surges, making the beaten-down gold stocks
a coiled spring
today. They are overdue to soar again!
Though this contrarian sector is widely despised now, it was the
best-performing in all the stock markets last year despite that
sharp post-election selloff in Q4. The HUI blasted 64.0% higher in
2016, trouncing the S&P 500’s mere 9.5% gain! Similar huge 50%+
gold-stock gains are likely again in 2018, as gold mean reverts
higher on the
coming stock-market selloff. The gold miners’ strong Q3
fundamentals prove this.
Given GDXJ’s serious problems, leading to diverting most of its
capital inflows into larger gold miners that definitely aren’t
juniors, you won’t find sufficient junior-gold exposure in this
troubled ETF. Instead traders should prudently deploy capital in
the better individual mid-tier and junior gold miners’ stocks with
superior fundamentals. Their upside is vast, and would trounce
GDXJ’s even if it was still working as advertised.
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 Q3, this has resulted in 967 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 +19.9%!
The key to this
success is staying informed and being contrarian. That means
buying low when others are scared, like
late in this year’s vexing consolidation. An easy way to
keep abreast is through our acclaimed
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The
bottom line is the mid-tier gold miners now dominating GDXJ enjoyed
strong fundamentals in their recently-reported Q3 results. While
GDXJ’s radical composition changes since last year muddy annual
comparisons, today’s components mined lots more gold at lower
costs. These gold miners continued to earn hefty 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. | 
