The
junior gold miners’ stocks have spent much of the past year grinding
sideways near lows, sapping confidence and breeding widespread
bearishness. The entire precious-metals sector has been left for
dead, eclipsed by the dazzling taxphoria stock-market rally. But
traders need to keep their eyes on the fundamental ball so herd
sentiment doesn’t mislead them. The juniors’ recent Q4 results
proved quite strong.
Four
times a year publicly-traded companies release treasure troves of
valuable information in the form of quarterly reports. Required by
securities regulators, these quarterly results are exceedingly
important for investors and speculators. They dispel all the
sentimental distortions surrounding prevailing stock-price levels,
revealing the underlying hard fundamental realities. That
serves to re-anchor perceptions.
Normally quarterlies are due 45 calendar days after quarter-ends, in
the form of 10-Qs required by the SEC for American companies. But
after the final quarter of fiscal years, which are calendar years
for most gold miners, that deadline extends out up to 90 days
depending on company size. The 10-K annual reports required once a
year are bigger, more complex, and need fully-audited numbers unlike
10-Qs.
So
it takes companies more time to prepare full-year financials and
then get them audited by CPAs right in the heart of their busy
season. The additional delay in releasing Q4 results is certainly
frustrating, as that data is getting stale approaching the end of
Q1. Compounding the irritation, some gold miners don’t actually
break out Q4 separately. Instead they only report full-year
results, lumping in and obscuring Q4.
I
always wonder what gold miners that don’t report full Q4 results are
trying to hide. Some Q4 numbers can be inferred by comparing
full-year results to the prior three quarterlies, but others aren’t
knowable if not specifically disclosed. While most gold miners
report their Q4 and/or full-year results by 7 to 9 weeks after
year-ends, some drag their feet and push that 13-week limit. That’s
very disrespectful to investors.
All
this unfortunately makes Q4 results the hardest to analyze out of
all quarterlies. But delving into them is still well worth the
challenge. There’s no better fundamental data available to
gold-stock investors and speculators than quarterly results, so they
can’t be ignored. They offer a very valuable true snapshot of
what’s really going on, shattering all the misconceptions bred by
the ever-shifting winds of sentiment.
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 $7.9b. 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 major problems for GDXJ over the
past couple years, severely hobbling its usefulness to investors.
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 solution.
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 intermediate gold miners, while greatly demoting true smaller
junior gold miners in terms of their ETF weightings. This
controversial move defying many decades of convention was done
stealthily behind the scenes to avoid outrage.
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’ Q4’17 earnings
season in late March, I dug into the top 34 GDXJ components. That’s
just an arbitrary number that fits neatly into the tables below.
Although GDXJ included a staggering 73 component stocks in late
March, the top 34 accounted for a commanding 80.5% of its total
weighting.
Out
of these top-34 GDXJ companies, only 4 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 8.1% of GDXJ’s total
weighting. But even that is really overstated, as half of these are
long-time traditional major silver miners that have started
diversifying into gold in recent years.
GDXJ
is inarguably now a pure mid-tier gold-miner ETF. That would
be great if GDXJ was advertised as such. But it’s very misleading
if investors still believe this dominant “Junior Gold Miners ETF”
still gives exposure to junior gold miners. I suspect the vast
majority of GDXJ shareholders have no idea just how radically its
holdings have changed since early 2016, and how much it has strayed
from its original mission.
I’ve
been doing these deep quarterly dives into GDXJ’s top components for
years now. In Q4’17, fully 31 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 there’s no reason for them
to 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 31 GDX components accounted for 76.7% of GDXJ’s total
weighting, not just its top 34. They also represented 32.2% of
GDX’s total weighting. So over 3/4ths of the junior gold
miners’ ETF is made up of nearly a third of the major gold miners’
ETF! These GDXJ components in GDX start at the 12th-highest
weighting in that latter larger ETF and extend down to 44th. Do
investors know GDXJ is mostly GDX gold stocks?
Fully 11 of GDXJ’s top 17 components weren’t even in this ETF a year
ago in Q4’16. They alone now account for 36.6% of its total
weighting. 16 of the top 34 are new, or 43.8% of the total. In the
tables below, I highlighted the symbols of companies that weren’t in
GDXJ a year ago in light blue. GDXJ has changed radically, and
analyzing its top components’ Q4’17 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 or 10-Ks, and dump it into a big spreadsheet for analysis.
The highlights made it into these tables. Blank fields mean a
company did not report that data for Q4’17 as of this Wednesday.
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 this week. While many 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
Q4’17 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 Q4’16.
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 are a couple exceptions to
these YoY changes.
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
numbers instead of weird or misleading percentage changes. This
whole dataset offers a fantastic high-level read on how the
mid-tier gold miners are faring today as an industry. Contrary
to their low stock prices, they’re doing quite well.
After spending days digesting these GDXJ gold miners’ latest
quarterly reports, it’s fully apparent their vexing low
consolidation over the past year isn’t fundamentally righteous
at all! Traders have abandoned this sector 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 top-34 GDXJ
components that weren’t included a year ago in Q4’16. And the
meager yellow-highlighted weightings are the only stocks that were
not also GDX components in late March! GDXJ is increasingly a
GDX clone that offers little if any real exposure to true
juniors’ epic upside potential during gold bulls. Sadly this ETF
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 sizes of individual miners. That
would make both GDX and GDXJ much more targeted and useful for
investors.
VanEck could greatly increase the utility and thus ultimate success
of both GDX and GDXJ by starting with one 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. That would
run down near 150k or 105k ounces of quarterly production based on
Q4’17 data. Then the next-largest 30 or 40 gold miners could be
assigned to GDXJ.
The
worst part of GDXJ now including mid-tier gold miners instead of
real juniors is the latter are being relentlessly starved of
capital. As investment capital flows into ETFs, they have to
buy shares in their underlying component companies. That naturally
bids their stock prices higher. But in GDXJ’s case, the capital
investors intend to use to buy juniors is being stealthily diverted
into much-larger mid-tier gold miners.
While there are still some juniors way down the list in GDXJ’s
rankings, they collectively make up about 20% of this ETF’s
weighting at best. Junior gold miners rely heavily on issuing
shares to finance their exploration projects and mine builds. But
when their stock prices are down in the dumps because no one is
buying them, that is heavily dilutive. GDXJ is effectively
strangling the very industry its investors want to own!
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 4193k ounces in
Q4’17. That rocketed 87% higher YoY, but that comparison is
meaningless given the radical changes in this ETF’s composition
since Q4’16. On the bright side, GDXJ’s miners do still remain
much smaller than GDX’s.
GDX’s top 34 components, fully 19 of which are also top-34 GDXJ
components, collectively produced 10,337k ounces of gold in Q4. So
GDXJ components’ average quarterly gold production of 140k ounces
excluding explorers was 57% lower than GDX components’ 323k
average. In spite of GDXJ’s very-misleading “Junior” name, it
definitely has smaller gold miners even if they’re way above that
75k junior threshold.
Despite GDXJ’s top 34 components looking way different from a year
ago, these current gold miners are generally faring well on the
crucial production front. 17 of these mid-tier gold miners enjoyed
big average production growth of 30% YoY! Overall average growth
excluding explorers was 12.2% YoY, which is far better than world
mine production which slumped 1.7% lower YoY in Q4’17 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 Q4’17, these top-34
GDXJ-component gold miners that reported cash costs averaged just
$618 per ounce. That was actually up a slight 0.5% YoY, so the
higher production failed to force costs lower.
This
was still quite impressive, as the mid-tier gold miners’ cash costs
were only a little higher than the
GDX majors’ $600.
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 $618 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 gold mines as ongoing concerns. 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
Q4’17, these top-34 GDXJ components reporting AISCs averaged just
$855 per ounce. That only rose 0.1% YoY, effectively dead flat,
despite the new mix of GDXJ components. That also compares very
favorably with the GDX majors, which saw nearly-identical
average AISCs at
$858 in Q4. The mid-tier gold miners’ low costs prove they are
faring far better fundamentally today than their low stock prices
imply.
All-in sustaining costs are effectively this industry’s breakeven
level. As long as gold stays above $855 per ounce, it remains
profitable to mine. At Q4’s average gold price of $1276, these top
GDXJ gold miners were earning big average profits of $421 per ounce
last quarter! That equates to fat profit margins of 33%, 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 Q4’17,
this ETF averaged $32.62 per share. That was down a considerable
10.2% from Q4’16’s average of $36.34. Investors have largely
abandoned gold miners because they are captivated by the extreme
taxphoria stock-market rally since the election. Yet gold-mining
profits certainly didn’t justify this.
A
year ago in Q4’16, the top-34 GDXJ components at that time also
reported average all-in sustaining costs of
$855 per ounce.
With gold averaging $1218 then which was 4.6% lower, that implies
the mid-tier gold miners were running operating profits of $363 per
ounce. Thus Q4’17’s $421 surged 16.0% YoY, a heck of a jump! Yet
the mid-tier gold miners’ stock prices irrationally slumped
substantially lower.
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. This
really happened in GDXJ over the past year despite its radical
changes in composition. A 4.8% gold rally in quarterly-average
terms catapulted operating profits 16.0% higher, or 3.3x. That’s
right in line with the typical leverage of gold-mining profits to
gold prices of several times or so.
But
this strong profitability sure isn’t being reflected in gold-stock
prices. GDXJ shouldn’t have been lower in Q4’17 with mining profits
much higher. The vast fundamental disconnect in gold-stock
prices today is absurd, and can’t last forever. Sooner or later
investors will rush into the left-for-dead gold stocks to bid their
prices far higher. This bearish-sentiment-driven anomaly has grown
more extreme in 2018.
Since gold-mining costs don’t change much quarter-to-quarter
regardless of prevailing gold prices, it’s reasonable to assume the
top GDXJ miners’ AISCs will largely hold steady in the current
Q1’18. And it’s been a strong quarter for gold so far, with it
averaging over $1328 quarter-to-date. If the mid-tier gold miners’
AISCs hold near $855, that implies their operating profits are now
running way up near $473 per ounce.
That
would make for a massive 12.4% QoQ jump in earnings for the mid-tier
gold miners in this current quarter! Yet so far in Q1 GDXJ is
languishing at an average of just $32.88, flatlined from Q4 where
gold prices and mining profits were considerably lower. The
mid-tier gold miners’ stocks can’t trade as if their profits don’t
matter forever, so an enormous mean-reversion rally higher is
inevitable sometime soon.
And
that assumes gold prices merely hold steady, which is unlikely.
After years of relentlessly-levitating stock markets thanks to
extreme central-bank easing,
radical gold
underinvestment reigns today. As the
wildly-overvalued
stock markets inescapably sell off on
unprecedented
central-bank tightening this year, gold investment will
really return to
favor. That portends super-bullish-for-miners higher gold
prices ahead.
The
impact of higher gold prices on mid-tier-gold-miner profitability is
easy to model. Assuming flat all-in sustaining costs at Q4’17’s
$855 per ounce, 10%, 20%, and 30% gold rallies from this week’s
levels would lead to collective gold-mining profits surging 45%,
77%, and 108%! And another 30% gold upleg isn’t a stretch at all.
In the first half of 2016 alone after the previous stock-market
correction, 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.
Given the radical changes in GDXJ’s composition over the past year,
normal year-over-year comparisons in key financial results simply
aren’t meaningful. The massive rejiggering of the index underlying
GDXJ didn’t happen until Q2’17, so it will be a couple quarters yet
until results finally grow comparable again. But in the meantime,
here are the apples-to-oranges reads on the GDXJ components’ key
financial results.
The
cash flows generated from operations by these top-34 GDX components
rocketed 104.5% higher YoY to $1743m. That helped boost their
collective cash balances by 53.9% YoY to $6577m. Sales were up
102.6% YoY to $4282m, roughly in line with the 87.4% gold-production
growth. But again GDXJ was way different a year ago, so this
impressive growth merely reflects bigger mid-tier gold miners
replacing true juniors.
As
long as OCFs remain massively positive, the gold mines are
generating much more cash than they cost to run. That gives the
gold miners the capital necessary to expand existing operations and
buy new deposits and mines. Given how ridiculously low gold-stock
prices are today, you’d think the gold miners are hemorrhaging cash
like crazy. But the opposite is true, showing how silly this
bearish herd sentiment is.
Unfortunately the GAAP earnings picture looked vastly worse. These
top-34 GDXJ gold miners reporting Q4 earnings collectively lost
$317m, compared to a minor $2m profit in Q4’16. While that
certainly looks like a disaster, it’s heavily skewed. Excluding 3
big mid-tier gold miners that reported huge losses in Q4, the other
11 of these top GDXJ gold miners reporting earnings actually earned
an impressive $212m in profits.
Yamana Gold, New Gold, and Endeavour Mining suffered huge $200m,
$196m, and $134m losses in Q4’17. In each case these resulted from
large impairment charges. As mines are dug deeper and gold
prices change, the economics of producing this metal change too.
That leaves some of the mid-tier gold miners’ individual mines worth
less going forward than the amount of capital invested to develop
them.
So
they are written off, resulting in big charges flushed through
income statements that mask operating profits. But these writedowns
are something of an accounting fiction, non-cash expenses not
reflective of current operations. They are mostly isolated one-time
events as well, not representing earnings trends. As gold continues
to march higher in its young bull, impairment charges will vanish as
mining economics improve.
So
overall the mid-tier gold miners’ fundamentals looked quite strong
in Q4’17, a stark contrast to the miserable sentiment plaguing this
sector. Gold stocks’ vexing consolidation over the past year or so
isn’t the result of operational struggles, but purely bearish
psychology. That will soon shift as stock markets inevitably
roll over and gold surges, making the beaten-down gold stocks
a coiled spring
overdue to soar dramatically.
Given GDXJ now diverting most of its capital inflows into larger
mid-tier gold miners that definitely aren’t juniors, you won’t find
sufficient junior-gold exposure in this now-mislabeled 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 Q4, this has resulted in 983 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 +20.2%!
The key to this
success is staying informed and being contrarian. That means
buying low before others figure it out, before undervalued gold
stocks soar much higher. An easy way to keep abreast is through our
acclaimed weekly
and monthly
newsletters. They draw on my 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. For only $12 per issue,
you can learn to think, trade, and thrive like contrarians.
Subscribe today,
and get deployed in the great gold and silver stocks in our full
trading books!
The
bottom line is the mid-tier gold miners now dominating GDXJ enjoyed
strong fundamentals in their recently-reported Q4 results. While
GDXJ’s radical composition changes since last year muddy annual
comparisons, today’s components mined lots more gold at dead-flat
costs. These miners continued to earn fat 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. | 
