Gold mid-tiers’ Q2 2020 fundamentals

Ironically the leading mid-tier gold-stock benchmark and trading vehicle is the misleadingly-named GDXJ VanEck Vectors Junior Gold Miners ETF. It has evolved to be dominated by mid-tiers, miners yielding quarterly gold output of 75k to 250k ounces. GDXJ actually holds few true juniors, which only account for a small fraction of its total weighting. The mid-tier gold miners have enjoyed outstanding performance this year.

But it sure hasn’t come easy, as usual in the super-volatile gold-stock realm. By late February 2020, this popular ETF had climbed 6.4% year-to-date. But then heavy general-stock-market selling erupted, which snowballed into a rare full-blown panic. That spawned an epic maelstrom of fear that sucked in gold and thus its miners’ stocks. Over the next few weeks into mid-March, GDXJ collapsed 50.7% climaxing in a crash!

But those extreme gold-stock lows were fundamentally-absurd given the high prevailing gold prices. So we started aggressively buying and recommending gold stocks in our subscription newsletters. Those were mostly mid-tiers with superior fundamentals, which are the sweet spot for upside potential during major gold uplegs. And the resulting gains out of that wild stock-panic anomaly indeed proved massive.

Over the next 4.8 months into early August, GDXJ skyrocketed a spectacular 188.9% higher! Hardened contrarians who bought in early and low had the opportunity to nearly triple their capital in stocks, which is very unusual in such a short span of time. But the mid-tiers’ blistering run blasted GDXJ to exceedingly-overbought levels. This ETF was stretched 1.534x above its 200dma when it carved its latest interim high!

Extremely-stretched technicals which always spawn extremely-lopsided sentiment never last long. GDXJ soon started correcting out of that euphoric peak, plunging 13.8% in just 4 trading days! Corrections are healthy and necessary within ongoing bull markets to rebalance sentiment, eradicating excessive greed and euphoria. GDXJ remained up 30.6% YTD even after that. Do mid-tiers’ Q2’20 results justify such gains?

Last quarter was a strange one for the gold miners, with powerful bullish and bearish forces warring. Its average gold price of $1714 was the best on record, rocketing 30.9% YoY from Q2’19’s average! Gold-mining profits really amplify higher prevailing gold prices. But many gold miners around the world were forced to shutter for weeks or months on end by governments’ draconian national lockdowns to slow COVID-19.

So many gold miners couldn’t fully capitalize on the phenomenal windfall of the highest quarterly gold prices ever seen. That called into question whether GDXJ’s huge 76.4% gain in Q2 proper, over half of its colossal post-panic upleg, was fundamentally-justified. So I couldn’t wait to see how the mid-tier gold miners actually fared operationally and financially last quarter, whether shutdowns or high gold prevailed.

I’ve painstakingly analyzed the mid-tier gold miners’ latest results for 17 quarters in a row now. While GDXJ included a ridiculously-bloated 79 component stocks this week, I limited my analysis to its top 25 holdings. They collectively accounted for 69.9% of its total weighting, certainly a commanding sample. These larger GDXJ stocks include some of the best-performing gold and silver miners in the world.

The GDXJ top 25 trade in the US, Australia, the UK, Canada, and Mexico, making amassing this data somewhat challenging. There are different financial-reporting requirements around the globe, and even within the same country miners report different data in different ways. In the few cases where half-year results were all that was offered, they were split in half to approximate what those companies did in Q2.

This table summarizes the Q2’20 operational and financial highlights from the GDXJ top 25. These mid-tier gold miners’ symbols are listed, some of which are from their primary foreign stock exchanges. That is preceded by their ranking changes in terms of GDXJ weightings from Q2’19. Then their current weightings as of this week follow those stock symbols. GDXJ essentially ranks components by market capitalizations.

So relative ranking changes help illuminate outperformers and underperformers over the past year. That data is followed by each miner’s Q2’20 gold production in ounces, and its year-over-year change from Q2’19’s results. Then comes cash costs per ounce and all-in sustaining costs per ounce along with their YoY changes, revealing how much it costs these mid-tiers to wrest their gold from the bowels of the earth.

Next quarterly revenues, earnings, operating cash flows generated, and cash on hand are listed along with their YoY changes. Blank data fields mean companies hadn’t reported that particular data as of the middle of this week. Blank percentage fields indicate those changes would either be misleading or not meaningful, from comparing two negative numbers or when data shifts from positive to negative and vice versa.

Because of that epic tug-of-war between record-high average gold prices and COVID-19 shutdown orders plaguing mines, the mid-tier gold miners have never seen a quarter like Q2’20. But they still generated relatively-strong operational results despite many mines hobbled by decree. And their financial results proved outstanding with gold prices so darned high. This sector’s massive gains were fundamentally righteous!

While GDXJ is the highest-performing gold-stock ETF out of the larger popular ones, it is certainly no longer a junior-gold-stock ETF as advertised. Only two of the GDXJ-top-25 components qualified as junior golds, deriving over half their quarterly revenues from sub-75k-ounce gold output! Their production last quarter is highlighted in blue, and both these companies have long been better known for silver mining.

Rather unusually, the GDXJ top 25 included three new components last quarter. These included Mexican silver-mining giants Fresnillo and Industrias Penoles. The former is the largest silver miner in the world, producing 13.6m ounces in Q2 alone! That catapulted these mid-tiers’ silver output 120.0% higher YoY to 41.7m ounces. But neither company is a primary silver miner, it accounted for 42% and 27% of their Q2 sales.

They added to the mid-tier gold miners dominating GDXJ’s ranks. Together the GDXJ top 25 collectively produced 4.1m ounces of gold in Q2’20. That was down 6.7% YoY from Q2’19, reflecting the impact of the various government-imposed national economic lockdowns to slow the spread of COVID-19. While that sounds like a big production hit, it is actually surprisingly mild. Mid-tiers’ output well outperformed their peers’.

In last week’s essay I analyzed the quarterly results from the top 25 components of the GDX major-gold-miners ETF. Their total production actually plunged 11.0% YoY to 7.6m ounces, considerably worse than the GDXJ top 25. And the World Gold Council reported that overall global mine output collapsed 10.0% YoY in Q2 to 25.0m ounces. So the GDXJ top 25 were well ahead only seeing their total output fall 6.7%.

And that production decline is considerably overstated, because of Harmony Gold. It is the only GDXJ-top-25 miner that hadn’t reported Q2 gold output as of the middle of this week. Largely focused in South Africa, that government’s COVID-19 lockdowns hit its miners hard. Underground gold mining was totally suspended from late March to early May, when it was permitted to resume at 50% capacity until early June.

Then full operations could spin back up. But surface mining was largely exempted from the lockdowns, with operations running at close to 100% capacity throughout those months. Because of Q2’s massive disruptions, South Africa’s securities regulator extended Q2 reporting deadlines. Harmony’s fiscal year ends Q2, and full-year results including last quarter have to be audited. They are delayed at least a month.

While it is ridiculous this company didn’t report preliminary Q2 gold production, it did mention its “South African operations managed to achieve up to 75% of planned production during the last quarter of the financial year”. A year earlier in Q2’19, Harmony’s gold output ran 357k ounces. 3/4ths of that works out to 268k, but 2/3rds is a more-conservative assumption since this company also mines gold in Papua New Guinea.

If Harmony produced 238k ounces of gold in Q2, that would boost the GDXJ top 25’s total output closer to 4.4m. Amazingly that would only be down 1.3% YoY, radically better performance than the major gold miners! And interestingly the GDXJ top 25 are mostly a subset of the GDX-top-25 gold miners, excluding the latter’s eight largest components. Fully 17 of the GDXJ-top-25 companies are also GDX-top-25 ones.

The GDXJ-top-25 gold miners in this table account for both 69.9% of GDXJ’s total weighting and 30.9% of GDX’s total weighting. But GDXJ throwing out the world’s largest gold miners, and weighting the smaller mid-tiers more heavily, drives its big outperformance. During that post-panic upleg where GDXJ skyrocketed 188.9% higher, GDX’s comparable 134.1% surge was much smaller. Mid-tiers trounce the majors.

The major gold miners are simply too big to grow fast, both in gold-output and market-capitalization terms. The top 8 GDX components that GDXJ doesn’t include averaged 570k ounces of gold production in Q2. And their average market capitalization in the middle of last week ran $30.5b. That compares to 180k and $5.2b for the GDXJ top 25. Coming from much-smaller bases, growth comes much easier for mid-tiers.

These sweet-spot gold miners usually have a few mines, so adding another one really boosts their gold output. Yet the majors are so big that mine expansions, builds, and acquisitions can’t even keep up with depletion. They almost never show the output growth traders prize above everything else. And the stock prices of smaller companies in market-cap terms are much more responsive to capital inflows than larger ones.

The GDXJ top 25’s stable production was even more impressive considering the impacts of lockdowns for some of its components. Pan American Silver, which is GDXJ’s third-largest weighting this week, is an excellent example. Despite its name, it is now overwhelmingly a primary gold miner with only 18% of Q2 revenues coming from silver. PAAS’s Q2 gold production plummeted 37.5% YoY, among the worst in GDXJ.

That was solely because Pan American had the misfortune of being heavily concentrated in countries with some of the most-draconian national economic lockdowns. Those include Peru and Mexico, where nearly 3/4ths of PAAS’s 2019 revenues came from. Other GDXJ-top-25 components with huge plummetings in Q2 outputs YoY, including Buenaventura and First Majestic Silver, also do their mining in these countries.

Normally such sharp output drops would cause serious concerns, since production is the lifeblood of this industry. The more gold miners produce, the greater their profits supporting higher future stock-price levels. But profits leverage to gold works both ways, so when output falls future earnings potential drops dramatically. Thankfully those COVID-19 disruptions were temporary, quickly reversing as lockdowns lifted.

Most of the affected mid-tiers reported operating tempos at shuttered mines were back up nearing full speed by the end of Q2. So the GDXJ top 25’s gold production should rebound sharply in Q3, surging back up near or even above normal levels as miners rush to make up for lost output. Q2’20’s widespread national lockdowns shuttering gold mines likely won’t be repeated, they proved far too costly for those countries.

Any future lockdowns are likely to be narrowly targeted to COVID-19 outbreak areas, which will be much less damaging economically, socially, politically, and medically. And regional flare-ups of this virus aren’t likely to affect gold mines much. They are usually remote out in the mountains, and have limited highly-controlled access so workers can be screened. The worst of COVID-19’s gold-mining impact has likely passed.

In gold mining, output and costs are inversely proportional. The more gold mined, the more ounces to spread this industry’s big fixed costs across. Those generally don’t change much from quarter to quarter regardless of prevailing gold prices. Individual mines require the same levels of infrastructure, equipment, and employees to feed their fixed-capacity mills quarter after quarter. So lower outputs mean higher unit costs.

And that doesn’t even include all the new costs for managing this pandemic, something the gold miners have never had to do. Testing for the virus, quarantining the afflicted, and relentlessly social distancing and cleaning to limit its spread all require more resources and people. So gold-mining operating costs had to increase with these many new COVID-19 burdens, completely independent from gold production.

Cash costs are the classic measure of gold-mining costs, including all cash expenses necessary to mine each ounce of gold. But they are misleading as a true cost measure, excluding the big capital needed to explore for gold deposits and build mines. So cash costs are best viewed as survivability acid-test levels for the mid-tier gold miners. They illuminate the minimum gold prices necessary to keep the mines running.

The GDXJ top 25 reported average cash costs of $707 in Q2, which merely edged up 2.2% YoY. That was on the higher side of their 17-quarter range from $608 to $749, but still super-low relative to high prevailing gold prices. Obviously with gold enjoying that record quarterly average price of $1714 in Q2, the mid-tiers faced no existential threat. Cash costs are really only relevant when gold plumbs secular lows.

All-in sustaining costs are far superior than cash costs, and were introduced by the World Gold Council in June 2013. They add on to cash costs everything else that is necessary to maintain and replenish gold-mining operations at current output tempos. AISCs give a much-better understanding of what it really costs to maintain gold mines as ongoing concerns, and reveal the mid-tier gold miners’ true operating profitability.

The GDXJ top 25 reporting AISCs averaged $998 per ounce last quarter, which only climbed 3.4% YoY. And that was skewed high by that Peruvian gold and silver miner Buenaventura. Peru’s heavy-handed lockdown nearly slashed BVN’s gold output in half, doubling its AISCs to an extreme anomalous high way up at $1598! Excluding that crazy outlier, the rest of the GDXJ top 25 averaged lower $966 AISCs in Q2.

Both reads were lower than the last 17 quarters’ highest GDXJ-top-25 average AISC of $1016. That hit in Q1’20 as COVID-19 lockdowns began. Even including BVN, the mid-tiers’ 3.4% YoY increase in AISCs was far better than the GDX-top-25 majors seeing their own average AISCs shoot 13.1% higher YoY! The mid-tiers holding the line on costs despite all the pandemic challenges made for spectacular profitability.

The best quick proxy for sector gold-mining earnings is calculated by subtracting quarterly average AISCs from quarterly average gold prices. $1714 less $998 yields GDXJ-top-25 implied earnings of $717 per ounce last quarter! That skyrocketed an astounding 108.2% YoY from the $344 profits this metric implied a year earlier in Q2’19. Those massive mid-tier gold-mining profits were the highest yet seen by far in this bull.

With implied profits more than doubling, GDXJ’s huge 76.4% Q2’20 gain seems modest. It was certainly justified by the vastly-improved fundamentals that much-higher gold prices drive. And super-bullishly for mid-tier gold miners’ stock prices going forward, their earnings power continues to soar. The underway Q3 which is more than halfway over has already seen gold average a dazzling new all-time-record $1899!

But like gold stocks, gold is extremely overbought and really needs to correct to rebalance sentiment. Yet even if it falls sharply enough to drag Q3’s average price down to $1825, that still dwarfs Q2’s $1714 average. And the GDXJ top 25’s AISCs aren’t likely to change much from their four-quarter average now running $984. That’s conservative, higher output with shut-in production rebounding should push AISCs lower.

These cautious and sober Q3 projections yield potential GDXJ-top-25 earnings of $841 per ounce this quarter. That would keep soaring another 61% YoY from Q3’19’s levels! And that’s nothing new. During the last four reported quarters ending in Q2, mid-tier gold-mining profits per this sector proxy soared 65%, 72%, 66%, and 108% YoY! With sustained earnings growth like this, traders should be flocking in to the mid-tiers.

Their hard financial results reported to securities regulators, under Generally Accepted Accounting Principles or their foreign equivalents, proved outstanding in Q2 despite the operational challenges from governments’ lockdowns. The GDXJ top 25’s total revenues grew 15.7% YoY to $6.4b. And those are actually really understated, because of that financial-reporting delay authorized by South Africa’s regulators.

When I did this same analysis a year ago for Q2’19, the major South African gold miners Gold Fields and Harmony Gold had fully reported. If their year-ago revenues are backed out, the GDX top 25 saw Q2’20 sales rocket 46.3% higher YoY. The mid-tiers’ bottom-line accounting earnings soared 68.6% higher YoY to $454m, massive growth in line with that implied-earnings proxy! Again GDXJ’s 76.4% Q2 gain was righteous.

Excluding the South African gold miners’ Q2’19 profits doesn’t materially change that, they proved a wash last year. But it does affect operating cash flows. The GDXJ top 25 saw total OCFs surge 34.9% YoY to $2.7b. But without the prior-year OCFs reported on time by GFI and HMY, that comparison blasts way up to +57.9% YoY. That high OCF generation helped boost GDXJ-top-25 treasuries by 63.1% YoY to $8.9b.

Without that pair of South African miners, cash soared 83.4% YoY. Given the unprecedented uncertainty gold miners face from governments’ draconian overreactions to COVID-19, they also tapped lines of credit to maintain ample liquidity to weather any operational storms. That $8.9b in cash among the GDXJ top 25 was the highest by far in the 17 quarters I’ve been doing this analysis. Mid-tiers are ready for more lockdowns.

But that lockdown threat is fading fast as governments realize garroting their own economies is a cure far more damaging than the COVID-19 disease. So as gold miners’ lockdown fears wane, they will be flush with cash to expand their outputs. The coming year will likely see plenty of announcements of big mine expansions, new mine builds, and mergers and acquisitions. That will generate lots of sector interest!

Overall Q2’20 proved really strong for the mid-tier gold miners. While they did face mine shutterings from governments’ national lockdowns, their collective output only shrunk modestly. That far outperformed the big drops from the major gold miners. Holding gold production relatively stable combined with the record average gold prices in Q2 to drive outstanding financial results. The mid-tiers remain gold stocks’ sweet spot!

Given the enormous earnings these higher prevailing gold prices are generating at mid-tier gold miners, additional massive gains in their secular bull are certainly fundamentally-justified. Even though GDXJ just enjoyed that huge 188.9% post-stock-panic upleg, this gold-stock bull’s next upleg is likely to prove really big too. But we first have to get through healthy gold and gold-stock corrections following extreme overboughtness.

All bull markets naturally flow then ebb, taking two steps forward before retreating one step back. Their price action gradually meanders around uptrends. This normal upleg-correction pattern keeps sentiment balanced, extending bull markets’ longevity. And it is a huge boon for traders, offering excellent mid-bull opportunities to buy relatively low before later selling relatively high. That greatly expands bulls’ potential gains!

At Zeal we started aggressively buying and recommending fundamentally-superior gold and silver miners in our weekly and monthly subscription newsletters back in mid-March right after the stock-panic lows. We layered into dozens of new positions before gold stocks grew too overbought, which were stopped out recently at huge realized gains running as high as +199%! Our subscribers multiplied their wealth within months.

To profitably trade high-potential gold stocks, you not only need to understand their fundamentals but stay informed about what’s driving gold. Our newsletters are a great way, easy to read and affordable. 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. Subscribe today and take advantage of our 20%-off sale! Corrections are the time to do your gold-stock homework, preparing to redeploy as they pass.

The bottom line is the mid-tier gold miners reported outstanding Q2 results. While COVID-19 lockdowns did affect their operations, their output shrinkage was much smaller than their larger peers’. That resulted in smaller cost increases, fueling enormous earnings growth in both sector-implied and hard-accounting terms. Revenues, operating cash flows generated, and treasury cash also all soared dramatically last quarter.

With the mid-tiers rolling in liquidity, they will likely invest billions in boosting their production as lockdown fears fade in coming quarters. And Q3 is shaping up to be another quarter seeing massive profits upside. With national lockdowns over, gold output is rebounding pushing costs lower. That along with much-higher-still record average gold prices shows big additional gold-stock gains remain fundamentally justified.

(By Adam Hamilton)