With
the third quarter’s earnings season now underway, the gold miners
will soon join in and report their latest results. No data is more
highly anticipated by investors, for good reason. Quarterly reports
dispel the dense fogs of herd sentiment that usually obscure gold
stocks, revealing their operations’ underlying fundamental
realities. Q3’17’s upcoming results are likely to prove quite
bullish for this neglected sector.
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. The gold miners generally release their quarterly
reports in the latter half of this span. So Q3’17’s will
arrive between late October and mid-November.
After spending decades intensely studying and actively trading this
contrarian sector, there’s no gold-stock data I look forward to more
than the miners’ quarterly financial and operational reports. They
offer a true and clear snapshot of what’s really going on,
shattering the misconceptions bred by ever-shifting winds of
sentiment. Nearly all fundamental analysis is based off the data
gold miners provide in these reports.
So
for many years I’ve delved deeply into gold miners’ quarterly
results. They are the dominant source of information I use to
winnow down the universe of gold stocks to the
fundamentally-superior ones with the greatest upside potential.
Every quarter after their latest earnings season ends, I research
and write essays discussing the newest results from the
major gold miners,
junior gold
miners, and
silver miners.
Q3’17’s analyses are coming starting in mid-November, once that
45-day post-quarter reporting deadline has passed. But before that
I eagerly dive into individual companies’ results as they’re
reported, since there’s so much to digest. And even earlier right
after a quarter ends, I start thinking about what gold miners’
latest quarterly results are likely to show collectively.
They can actually be predicted to some extent!
In
high-level fundamental terms, gold mining is a simple business.
These companies painstakingly wrest gold from the bowels of the
Earth, then generally sell all they can produce at prevailing market
prices. So their profits are effectively the difference between
current gold levels and operating costs. The former is easy to
calculate once a quarter ends, and the latter can be
fairly-accurately estimated for this sector as a whole.
Gold’s average closing price in Q3’17 was just under $1279, up 1.7%
sequentially from Q2’17’s average near $1258. Higher gold prices
portend better quarterly results, because gold-mining costs are
largely fixed. They are mostly determined back when mines are
being planned. That’s when engineers carefully decide which ore
bodies to mine, how to dig to them, and how to process the resulting
gold-bearing ore.
Quarter after quarter, generally the same numbers of employees,
excavators, haul trucks, and mills are used regardless of prevailing
gold prices. There are some variable costs like diesel fuel, but
they are dwarfed by massive fixed costs. Thus higher gold prices
flow right through directly to the miners’ bottom lines, boosting
profits. And the relationship between gold’s gains and higher
earnings is leveraged, not linear.
The
major gold miners are all included in the leading GDX VanEck Vectors
Gold Miners ETF, which is the world’s most-popular gold-stock
investment vehicle. Every quarter I dig into the latest results
from its top 34 component companies, which account for 90%+ of its
total weighting. In Q2’17, these top GDX major gold miners reported
average all-in sustaining costs of
$867 per ounce.
These AISC determine profits.
All-in sustaining costs include everything necessary to maintain
and replenish operations at current gold-production levels.
They include all direct and indirect cash costs of production,
exploration for new gold to mine to replace depleting deposits,
mine-development and construction expenses, remediation, and mine
reclamation. AISC are the most-important gold-mining cost metric by
far for investors to follow.
At
Q2’s $1258 average gold price and $867 average major-gold-miner
all-in sustaining costs, this sector was generating profits around
$391 per ounce. That’s pretty impressive, implying fat 31% profit
margins most other industries would die for. Making the reasonable
assumption that AISC will be pretty flat in Q3, its $1279 average
gold price would yield profits of $412 per ounce. That’s up 5.4%
quarter-on-quarter!
Potential 5.4% sequential gains in quarterly earnings in Q3’17 are
big absolutely, probably better than the great majority of
stock-market sectors. And 5.4% QoQ profits growth on a 1.7% QoQ
gold rally makes for excellent 3.2x profits leverage to gold
from the major gold miners. That’s the primary reason gold-mining
stocks yield such massive gains in rising-gold-price environments.
Their profits explode as gold rallies.
But
the major gold miners’ potential to bullishly surprise in their
upcoming third-quarter earnings season goes well beyond that.
Between Q2s and Q3s, all-in sustaining costs actually tend to
fall rather sharply. Last year between Q2’16 and Q3’16 for
example, the average AISC of GDX’s top-34-component major gold
miners fell 3.5% from $886 to $855. I fully expect to see a similar
third-quarter drop in AISC this year.
The
reason is global gold-mining production tends to surge
between Q2s and Q3s. This phenomenon is readily evident in the
latest data from the World Gold Council, which collects the best
gold fundamental data available. During the seven Q3s from 2010 to
2016, world gold production soared 8.0%, 4.4%, 5.3%, 9.0%, 8.8%,
6.1%, and 7.0% sequentially quarter-on-quarter from Q2 to Q3! That
averages out to +7.0%.
Such
big and consistent quarterly growth in Q3s is interesting. I
suspect at least a couple major factors feed into it, mining-plan
management to boost managers’ compensation and summer. The managers
of gold miners are usually partially paid in stock or stock options,
giving them big incentives to do everything they can to boost stock
prices. Their annual stock-based bonuses are usually figured late
in calendar years.
Thus
these guys seem to plan mining to attack any necessary lower-grade
ores that yield fewer ounces earlier in years if possible. Then
they shift back to higher-grade ores in the second halves when stock
prices matter more for compensation. Exceeding investors’
expectations of production rates in Q3s also leads them to bid
gold-mining stocks higher into year-ends, compounding gains
from mining-plan management.
In
addition most of the world’s major gold mines are in the northern
hemisphere, where mining is easier in the summer. The weather is
warmer and clearer, with less snow or monsoon rains to slow down
mining operations and mess with heap-leaching gold recoveries. I’m
amazed at the number of quarterly reports I’ve seen over the years
that attributed lower gold production to unexpected weather
interfering with operations.
Because most gold-mining costs are largely fixed, production and
costs are inversely related. The more ounces being produced
in any quarter, the more ounces to spread gold mining’s big fixed
costs across. So higher production directly leads to lower all-in
sustaining costs. Higher production and the resulting lower
per-ounce costs will make Q3’17’s results look way more bullish than
from just higher gold prices alone.
Gold
production varies seasonally within calendar years partially due to
mining-plan timing. Gold-bearing ore was certainly not created
equal, with even individual deposits seeing big internal variations
in their metal-to-waste-rock ratios. Miners often have to dig
through lower-grade ore to get to the higher-grade zones
underneath. This still has economically-valuable amounts of gold,
so it is run through the mills.
These mills are essentially giant rock grinders that break ore into
smaller pieces, vastly increasing its surface area for chemicals to
later leach out the gold. Mill capacity is fixed, with
limits on ore tonnage throughput. So when miners are blasting and
hauling lower-grade ore, fewer ounces are produced. As they
transition into higher-grade zones, the same amount of rock
naturally yields more payable ounces.
Regardless of the ore grades being blasted and milled, the overall
quarterly costs of mining don’t change much. Operations require the
same levels of employees, diesel, maintenance, and electricity no
matter how rich the rock being processed. So higher gold production
directly leads to lower per-ounce mining costs. The big fixed costs
of gold mining are spread across more ounces, making this business
more profitable.
Back
to the upcoming Q3’17 results from the major gold miners, where
profits should surge on the order of 5.4% QoQ due to higher gold
prices alone. Let’s conservatively assume their gold production
rose 4.0% sequentially, far below Q3’s 7.0% average since 2010 and
making for the worst Q3 growth in at least 8 years. Naturally 4%
higher gold production should lead to a proportional increase in
gold-mining profits.
That
takes the projected Q3’17 profits growth in the top major gold
miners included in GDX to the 9%-to-10% range quarter-on-quarter.
But that doesn’t take into account the lower production costs
generated by higher production. Once again a year ago in Q3’16, the
top 34 GDX components saw their average all-in sustaining costs fall
3.5% QoQ. Let’s conservatively assume average AISCs are 2.0% lower
in Q3’17.
That
would drag the major gold miners’ sector-wide AISC back down near
$850 per ounce. Incidentally that is totally plausible, in line
with Q3’16’s $855. At Q3’s average gold price near $1279 and $850
AISC, operating profits would surge to $429 per ounce. That’s up a
whopping 9.9% sequentially from Q2’17’s $391! Add in that 4% higher
production likely, and we’re talking big quarterly profits growth
around 14%.
Now
don’t read too much into the precise number, it’s merely an estimate
based on simple sector-level math. The Q3’17 profits growth in the
top-GDX-component major gold miners won’t exactly match, as each of
these individual companies will have its own triumphs or challenges
in Q3. The key takeaway here is we are set up for big quarterly
profits growth in the upcoming results of the major gold miners.
While 14% quarterly profits growth would be extreme for most other
stock-market sectors, it’s nothing for the gold miners.
Last year in
Q3’16, the average gold price surged a much-larger 6.0% QoQ to
$1334. That fueled a huge 41.6% QoQ surge in the total operating
cash flows generated by the top 34 GDX gold stocks, and a staggering
230.7% QoQ rocketing in their total GAAP accounting profits! 14% in
Q3’17 isn’t a stretch.
The
gold miners are truly set up to report excellent Q3’17 results in
the coming weeks. I expect to see many upside surprises fueled by
higher production and the resulting lower costs per ounce. That
might lead to widespread favorable guidance changes for
full-year 2017, upping production forecasts while lowering per-ounce
cost estimates. Good Q3’17 results will make investors take notice
of gold stocks again.
Any
material new capital inflows from impressed investors ought to light
a fire under today’s beaten-down gold stocks. While they enjoyed
some major
technical breakouts back in August,
gold’s sharp
pullback in September weighed heavily dragging them lower
again. That leaves the major gold miners’ stocks ready to rally
fast if good Q3’17 results start bringing back scared or indifferent
investors. The upside potential is huge.
All
stock prices are ultimately dependent on underlying corporate
profits. And for gold miners, nothing is more important for
earnings than prevailing gold prices. Again gold-mining profits
really leverage gold rallies, so their fundamental relationship is
ironclad. Higher gold drives higher gold-mining profits which leads
to higher gold-stock prices. And today gold stocks remain
radically undervalued relative to gold.
That
leaves them with lots of room to rally in the coming months if their
Q3’17 results indeed manage to impress investors. The HUI/Gold
Ratio is a great proxy for distilling down that core fundamental
link between gold prices and gold-stock prices. It simply divides
the daily close in the leading HUI NYSE Arca Gold BUGS Index that
mirrors GDX
by gold’s daily close, revealing whether gold stocks are high or
low.
As
this blue HGR line shows, gold stocks remain very low relative to
prevailing gold prices. This week the HGR was merely running
0.157x, which is extremely low historically. Gold stocks
have only been lower relative to the metal that drives their profits
briefly in late 2014, in much of 2015, and in the first few months
of 2016. That happened to be late in a major secular bear driven by
a deep parallel secular bear in gold.
If
today’s 0.16x HGR was actually righteous, it would’ve been seen
plenty of times in modern history. But it hasn’t been. Such
extremely-low gold-stock prices relative to gold were only able to
persist for a short spell late in a massive bear. But back
in early 2016, the gold stocks soared with gold to birth a major new
bull market. That persists to this day, with the HUI still up
101.5% bull-to-date since mid-January 2016.
With
gold stocks in a young bull market, seeing them at
deep-bear-low valuations relative to gold
is truly absurd.
It makes no sense at all fundamentally! Gold stocks have vast room
to rally from here merely to return to normal levels relative to
current gold prices. Good Q3’17 results could very well be one of
the sparks, along with gold rallying, that motivates investors to
resume returning and normalizing gold-stock prices.
Remember the Fed started
aggressively
levitating the US stock markets in early 2013, wreaking havoc on
alternative investments led by gold. The gold market’s last normal
years were sandwiched between 2008’s stock panic and 2013’s radical
Fed distortions. That’s the best recent baseline for where the HGR
ought to trade. And between 2009 to 2012, it was running way up at
0.346x. That’s over double today’s levels!
To
simply mean revert back up to those last normal levels relative to
gold, the major gold miners dominating the HUI and GDX would have to
power 120% higher from here to 447! To restore some semblance of
normalcy fundamentally, the gold stocks need to more than double
from here even at this week’s $1293 prevailing gold levels!
Gold stocks certainly can’t stay disconnected from their own
earnings realities forever.
All
markets are cyclical, including gold stocks. Extreme
undervaluations relative to gold are followed by overvaluations as
the pendulum swings back the other way. Mean reversions after
extremes never stop in the middle. Their momentum leads them to
overshoot to the opposite extreme! That makes gold stocks’ coming
upside far more impressive. A proportional overshoot heralds
radically-higher gold-stock prices ahead.
At
worst in mid-January 2016, the HGR fell to an all-time low of
0.093x. That was a staggering 0.253x under that post-panic
normal-year-average HGR of 0.346x. So a proportional overshoot
would briefly boost the HGR 0.253x above that mean, to 0.599x. Such
an upside extreme wouldn’t last long, as greed wouldn’t be
sustainable. But it could happen in a blowoff top after gold
stocks are popular following a bull.
At
$1293 gold, that yields a potential HUI topping target of 775!
That’s a stupendous 282% above this week’s levels. Is there any
other stock sector with the potential to quadruple in the coming
years? No way. Gold stocks are the only severely-undervalued
sector left after this Trumphoria stock rally, so their upside is
unparalleled. And incredibly these simple HGR-derived gold-stock
targets are actually conservative.
They
assume gold is static, stuck at $1293. That’s exceedingly
unlikely. As these Fed-levitated stock markets inevitably roll over
with Fed
quantitative tightening ramping up, gold itself will
catch a major bid
as investment capital returns. As a rare asset that generally moves
counter to stock markets,
gold is hostage
to them. So when the stock markets suffer their long-overdue
major selloff, gold will soar on capital inflows.
10%,
20%, and 30% gold uplegs from here would take this metal to $1422,
$1551, and $1680. Plug in the HGR of your choice, the post-panic
average or the mean-reversion overshoot, and you get some potential
HUI targets so high they defy belief. And don’t think a 30% gold
rally is out of the question. In response to the last
stock-market correction, gold powered 29.9% higher in just 6.7
months in early 2016!
Don’t get bogged down in HUI upside targets, they only serve to
illustrate a critical point for investors and speculators today.
Gold stocks are not only radically undervalued at today’s gold
prices, but even more so compared to where gold is heading in its
own still-very-much-alive bull market. Even if you think gold
stocks only have 50% to 100% upside, that’s vastly better than
everything else in these
overvalued stock
markets.
And
gold miners’ upcoming Q3’17 results could very well prove the
catalyst that ignites the next major gold-stock upleg. The large
gold miners will likely soon report big profits growth on higher
production and lower costs, easily surpassing investors’ low
expectations. As they start shifting capital back into this
forgotten sector, gold stocks will rally. That will soon attract in
other investors, fueling a self-feeding upleg.
While investors
and speculators alike can certainly play gold stocks’ coming upleg
with the major ETFs like GDX, the best gains by far will be won in
individual gold stocks with superior fundamentals. Their upside
will trounce the ETFs’, which are burdened by over-diversification
and underperforming gold stocks. A carefully-handpicked portfolio
of elite gold and silver miners will generate much-greater wealth
creation.
The
key to riding any gold-stock bull to multiplying your fortune is
staying informed, both about broader markets and individual
stocks. That’s long been our specialty at Zeal. My decades of
experience both intensely studying the markets and actively trading
them as a contrarian is priceless and impossible to replicate. I
share my vast experience, knowledge, wisdom, and ongoing research
through our popular newsletters.
Published weekly
and monthly,
they explain what’s going on in the markets, why, and how to trade
them with specific stocks. They are a great way to stay abreast,
easy to read and affordable. Walking the contrarian walk is very
profitable. As of the end of Q3, we’ve recommended and realized 967
newsletter stock trades since 2001. Their average annualized
realized gain including all losers is +19.9%! That’s hard to beat
over such a long span.
Subscribe today
and get invested before gold stocks power way higher!
The
bottom line is the major gold miners’ upcoming Q3’17 results should
show strong sequential profits growth. Q3’s higher average gold
prices alone will drive higher profits if gold-mining costs are
flat. But Q3s have a long history of seeing big sequential jumps in
gold-mining production directly leading to lower per-ounce costs.
If that proves true again last quarter, the major gold miners ought
to report excellent results.
The
potent combination of higher prevailing gold prices and bigger
production to spread gold mining’s large fixed costs across should
lead to sector profits surging rather dramatically. Investors will
likely take interest and start bidding gold stocks higher again,
fueling a major upleg. And since gold stocks remain so darned low
relative to prevailing gold prices, their upside from here is vast
as investment capital returns. | 
