Gold mid-tiers’ Q2 2022 fundamentals

Mid-tiers are much-less-risky than juniors, and amplify gold’s uplegs much more than majors. These mid-tiers are nicely tracked by the GDXJ VanEck Junior Gold Miners ETF. Birthed in November 2009, it now commands $3.4b of net assets making it the second-largest sector ETF after its big-brother GDX. While GDXJ is way-superior on multiple fronts, despite its name it is overwhelmingly comprised of mid-tier gold miners.

They are battered and left-for-dead now, after GDXJ cratered a brutal 41.2% between mid-April to mid-July! That carnage was fueled by a parallel 14.3% gold correction in roughly that same span, driven by huge gold-futures selling. Those leveraged speculators fled en masse after super-big-and-fast Fed rate hikes catapulted the benchmark US Dollar Index up 8.8% to 20.1-year highs! Gold stocks were collateral damage.

The mid-tiers suffered such relentless capitulation selling that GDXJ was slammed back down to stock-panic levels last seen briefly in early April 2020. But those crazy extremes weren’t sustainable then, and aren’t now. Over just 4.8 months out of those pandemic-lockdown stock-panic lows, GDXJ skyrocketed 188.9% higher! When gold stocks are the most out of favor is when traders should be rushing in to buy low.

Right after 25 quarterly earnings seasons in a row now, I’ve painstakingly analyzed the latest operational and financial results reported by the top-25 GDXJ gold miners. This week they collectively accounted for 62.1% of this ETF’s weighting. With a whopping 102 component stocks, GDXJ’s capital is spread across most of the better mid-tier-and-junior-gold-mining universe! Its larger holdings show how mid-tiers are faring.

Their latest Q2’22 results are more important than usual, with the biggest inflation super-spike since the 1970s raging. In April, May, and June, even the lowballed headline US Consumer-Price-Index inflation prints blasted up 8.3%, 8.6%, and 9.1% year-over-year! The latter proved the CPI’s worst read since way back in November 1981. Both gold and gold stocks were moonshots the last time inflation ran this red-hot.

This table summarizes the operational and financial highlights from the GDXJ top 25 in Q2’22. These gold miners’ stock symbols aren’t all US listings, and are preceded by their rankings changes within GDXJ over this past year. The shuffling in their ETF weightings reflects shifting market caps, which reveal both outperformers and underperformers since Q2’21. Those symbols are followed by their current GDXJ weightings.

Next comes these gold miners’ Q2’22 production in ounces, along with their year-over-year changes from the comparable Q2’21. Output is the lifeblood of this industry, with investors generally prizing production growth above everything else. After are the costs of wresting that gold from the bowels of the earth in per-ounce terms, both cash costs and all-in sustaining costs. The latter help illuminate miners’ profitability.

That’s followed by a bunch of hard accounting data reported to securities regulators, quarterly revenues, earnings, operating cash flows, and resulting cash treasuries. Blank data fields mean companies hadn’t reported that particular data as of the middle of this week. The annual changes aren’t included if they would be misleading, like comparing negative numbers or data shifting from positive to negative or vice versa.

The elite mid-tier and junior gold miners filling GDXJ’s upper ranks reported a challenging quarter. Their production growth was mixed, and higher mining costs eroding profitability were nearly universal. But the overall GDXJ-top-25 results were heavily skewed by both major ETF-composition changes and extreme outliers. Adjusting for these, mid-tier and junior gold miners are holding their own considering this backdrop.

Surprisingly three new-to-GDXJ components were added to its higher-weighted stocks during this past quarter, which is unusual. Super-major Kinross Gold is now a top “Junior Gold Miners ETF” component again, which doesn’t make any sense. Once a past top GDXJ component, it was booted during Q4’20. Expecting to mine about 2,150k ounces of gold this year, Kinross’s operations are far larger than mid-tier scale!

KGC belongs exclusively in GDXJ’s big-brother GDX ETF, which is dominated by major gold miners. I suspect the reason GDXJ’s managers re-added Kinross is because they needed a larger placeholder after removing Indonesia’s Merdeka Copper Gold. That was a good decision, because this company is overwhelmingly a copper and nickel miner that also operates a secondary small-junior-scale gold mine.

The Mexican silver giant Fresnillo was also added, which is a good fit for GDXJ. As the world’s largest silver miner, that is FRES’s primary metal in quarterly-revenues terms. But it does have sizable mid-tier gold operations as well. Finally another Indonesian base-metals miner Bumi Resources Minerals was added to GDXJ. But with sparse and poor English reporting, I haven’t been able to learn much about it yet.

Kinross turning up again like a bad penny really compromises production comparability. While it mined a colossal 558k ounces of gold last quarter, Merdeka produced less than 36k. So the GDXJ top 25’s total Q2 output surging 14.1% YoY to 2,913k ounces is fully a KGC distortion. Had that single component swap not been made, aggregate production would’ve actually fallen a way-worse 6.3% YoY to 2,392k ounces!

That would’ve been the worst overall output from these elite mid-tiers and juniors since way back in Q1’17. A couple other composition changes further skewed that lower though. The first was Australian super-major Newcrest Mining buying out Pretium Resources in Q4’21. The prior quarter it contributed 91k ounces to the GDXJ top 25. Bumi Resources’ addition also displaced a different junior from these ranks.

While that new company reported nothing, Wesdome Gold mined 27k ounces last quarter. So we could probably add back another 115k ounces or so, but even with that the GDXJ top 25’s output still shrunk 1.8% YoY. That was a major role reversal with the GDX-top-25 majors I analyzed in last week’s essay seeing 2.6%-YoY production growth in Q2’22! Usually majors struggle with output while mid-tiers thrive.

So last quarter was nothing to write home about operationally for mid-tiers. This should prove a single-quarter anomaly, since plenty of GDXJ-top-25 companies reported temporary setbacks at single mines eroded their overall production. Many elite mid-tiers see substantial output growth in the second half of 2022. But these struggles at individual companies highlight the importance of hand-picking gold stocks.

That’s also the only way to get meaningful junior exposure. Last quarter only four of these GDXJ-top-25 stocks qualified as juniors, primary gold miners deriving over half their revenues from the yellow metal while mining less than 75k ounces. Their outputs are highlighted in blue in this table, representing only 7.8% of this ETF. And nearly 2/3rds of that is long-time primary silver miners recently diversifying into gold.

K92 Mining is the only traditional junior gold miner in GDXJ’s upper ranks, at a mere 1.4% weighting! So while GDXJ is a great mid-tier gold-stock ETF, it certainly isn’t the “Junior Gold Miners ETF” advertised. Allocating meaningful capital to juniors requires buying their stocks individually. That’s always been one of our main focuses at Zeal, researching the junior universe to uncover the best fundamentally-superior ones.

The elephant in the room for the gold-mining sector is this raging inflation unleashed by years of extreme central-bank money printing. In just 25.5 months into mid-April 2022 for example, the Fed ballooned its balance sheet an insane 115.6% or $4,807b higher! That effectively more than doubled the US monetary base in just a couple years, leaving far more money chasing and bidding up the prices of goods and services.

Cost inflation was extensive in the GDX-top-25 majors’ Q2’22 results. Not surprisingly mid-tiers suffered these same pressures. In normal times, unit gold-mining costs are generally inversely-proportional to gold-production levels. That’s because gold mines’ total operating costs are largely fixed during pre-construction planning stages, when designed throughputs are determined for plants processing gold-bearing ores.

Their nameplate capacities don’t change quarter-to-quarter, requiring similar levels of infrastructure, equipment, and employees to keep running at full-speed. So the only real variable driving quarterly gold production is the ore grades fed into these plants. Those vary widely even within individual gold deposits. Richer ores yield more ounces to spread mining’s big fixed costs across, lowering unit costs and boosting profitability.

But while fixed costs are the lion’s share of gold mining, there are also sizable variable costs. Energy is the biggest category, including electricity to power ore-processing plants like mills and diesel fuel to run excavators and dump trucks hauling raw ores to those facilities. Other smaller consumables range from explosives to blast out ores to chemical reagents necessary to process various ores to recover their gold.

The GDXJ top 25’s generally-lower outputs would’ve driven their costs higher last quarter regardless of consumables prices. Less ores processed through mills or lower-grade ores both reduce gold ounces produced, forcing each to bear more fixed costs. But these elite mid-tier gold miners were also paying more for variable-cost consumables. That was a common theme through the majority of their quarterlies.

There were plenty of examples, including SSR Mining warning it was “continuing to face increased cost pressures especially in fuel, electricity, and reagents across the business that have outpaced our various cost mitigation efforts this year.” Hecla Mining said it was “seeing the impact of inflationary pressures and labor constraints at all its operations.” Labor costs tend to be sticky, unlike dynamic markets such as energy.

Equinox Gold declared “Cost escalation for certain consumables during the first half of 2022, including diesel, cyanide and grinding media, and lower grades processed than projected, has resulted in increased cash costs at several of the Company’s mines.” That prompted it to raise its full-year guidance for all-in sustaining costs. Other companies including First Majestic Silver and OceanaGold had to do the same thing.

AG upped its 2022 cost guidance “primarily due to inflationary pressures and higher costs” at one of its mines. OGC warned its “Full year AISC guidance is increased 7.5% … reflecting cost inflation impacts and lower expected copper by-product credits due to a lower expected copper price.” So inflation is a real challenge for the mid-tier and junior gold miners. Their mining costs soared at eye-popping rates last quarter.

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 mid-tier gold miners. They illuminate the minimum gold prices necessary to keep the mines running.

In Q2’22 these GDXJ-top-25 gold mid-tiers reporting cash costs averaged a shocking $974 per ounce! That soared 18.7% YoY, and was an ominous record high. That was also up big sequentially from the previous $894 peak from the preceding quarter. There’s no way to sugarcoat this, these cash costs are way too high. Thankfully they were heavily skewed by a couple extreme outliers that should soon retreat.

If just the crazy-high cast costs of $1,132 reported by Pan American Silver and $1,989 from First Majestic Silver are excluded, the rest of the GDX top 25 only averaged $900. That would merely edge up 0.8% over the previous Q1’22, showing far-better cost management in this inflation super-spike. PAAS and AG are both dealing with temporary single-mine problems, which they are assuring will shortly be resolved.

PAAS’s anomalously-high costs resulted from a shortfall at its largest gold mine. With just a couple years left until it is depleted, ore grades diverged from drilling results. So Pan American thinks drilling got lucky, striking higher-grade pockets than the wider ore body. So it partially wrote down that old mine, and made a negative inventory adjustment to account for less gold likely in ores stacked on that mine’s heap-leach pad.

AG continues to struggle to improve operating efficiencies and drive down costs at its lone primary gold mine acquired in late Q1’21. Plenty of improvements have been made, and management is forecasting costs falling dramatically later this year. Both the cash costs and all-in sustaining costs reported by that little gold mine in Q2 were some of the most extreme ever for a GDXJ-top-25 gold miner, a short-lived anomaly.

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 mid-tier gold miners’ true operating profitability.

The GDXJ top 25’s average AISCs last quarter were also dreadful, soaring a record 22.6% YoY to a scary new record high of $1,380! While that remains way below prevailing gold prices and thus plenty-profitable, such high costs really impair earnings. Thankfully those crazy AISC anomalies of $2,051 at PAAS and $2,429 at AG greatly skewed the overall average. Without those, that retreats sharply to $1,265.

While that’s still the highest on record, it is up a milder 12.4% YoY and 4.5% QoQ. That’s more reflective of how mid-tiers are actually faring on the all-in-sustaining-cost front. And these miners themselves see AISCs retreating this year as ore throughput rates improve, regardless of inflationary pressures. Without PAAS and AG, the rest of these GDXJ-top-25 miners with 2022 AISC guidances are averaging $1,194.

That would be pretty impressive for full-year AISCs if they come close, not terribly worse than their actual 2021 four-quarter average of $1,141 before this raging inflation spiraled out-of-control. Even PAAS and AG see their crazy AISCs really improving, guiding to $1,500 and $2,058 for all of 2022. Their two troubled mines only produced 54k ounces last quarter, or a mere 1.9% of the GDXJ top 25’s aggregate output.

So while last quarter’s mid-tier AISCs certainly looked ugly due to temporary production problems at some individual mines, lower ore grades, and inflationary pressures on consumables, these miners almost all see costs improving in coming quarters. On the inflation front specifically, most of the surging variable costs including energy will eventually retreat as their supply-and-demand situations inevitably normalize.

Electricity, diesel, explosives, and reagent chemicals aren’t going to keep surging forever. Supply will eventually catch up with then exceed demand forcing prices lower. In free markets, higher prices are self-correcting. They incentivize producers to bring on new production to chase high profits, which in turn soon drives prices lower. I’m on the edge of my seat now to see GDXJ-top-25 Q3’22 results in three months!

Still last quarter’s heavily-distorted $1,380 headline AISCs slammed the mid-tiers’ implied unit profitability. That’s the difference between quarterly-average prevailing gold prices and the GDXJ top 25’s average AISCs. The former ran a very-healthy $1,872 last quarter despite that heavy gold-futures dumping hitting gold, still up 3.2% YoY. But those ugly AISCs slashed this metric a massive 28.5% YoY to just $492 per ounce.

While that’s a serious deterioration from the prior eight quarters’ incredible $717 average, these are still hefty 26% profit margins on the price of gold! Most industries would sell their own souls to run margins like that, so the mid-tier gold miners are doing fine. And if those PAAS and AG single-mine anomalies are excluded from average AISCs, unit profits were closer to $607 per ounce which was only down 11.9% YoY.

The GDXJ top 25’s hard accounting data reported to securities regulators last quarter under Generally Accepted Accounting Principles or other countries’ equivalents was flat-out weak. That’s despite the re-inclusion of super-major Kinross Gold, which renders overall Q2’22 results almost not comparable with Q2’21’s. Overall revenues among these elite mid-tiers climbed a solid 7.7% YoY hitting $6,989m last quarter.

But if Kinross is removed from Q2’22’s total and Merdeka put back in, overall mid-tier sales slumped 3.9% YoY last quarter to $6,239m. That’s pretty lackluster, about what you’d expect with 6.3%-lower adjusted production and 3.2%-higher average gold prices. But even with Kinross, bottom-line accounting earnings for the GDXJ top 25 still cratered 61.4% YoY to just $308m! Those were fairly-clean in unique-item terms too.

I always look for unusual one-time gains or losses flushed through income statements, usually led by mine impairments and reversals. There weren’t any big ones last quarter, other than PAAS deciding to write down that troubled older gold mine where ore grades aren’t matching drilling by $99m. That is still on the smaller side for these, which tend to run at least several times larger at mid-tiers’ operational scales.

Unfortunately last quarter’s weaker earnings will drive up valuations. Thankfully they are low, averaging just 20.6x trailing-twelve-month price-to-earnings ratios among the GDXJ top 25 excluding three extreme outliers way over 100x. If the mid-tiers report strong Q3’22 results, those will really dampen the impact of Q2’s weak ones. And these gold miners themselves are again forecasting 2022’s second-half being way better.

Overall cash flows generated from operations only edged 0.1% lower to $1,920m last quarter, but without Kinross they would’ve rolled over a sharp 14.7%. That makes sense given the higher mining costs these gold stocks suffered. Their total cash treasuries still grew 9.2% YoY to $8,830m, but new super-major KGC was responsible for all those gains. Without it, cash was stable only edging up 0.3% YoY to $8,111m.

So Q2’22 was certainly a challenging quarter for the smaller gold miners. But their upside potential in coming quarters remains massive from these battered stock levels. Their updated guidances even with this raging inflation are forecasting average full-year-2022 AISCs coming in 7.9% lower than Q2’s scary $1,380. That alone would really boost profitability in Q3 and Q4 even if gold prices continue to languish.

But gold itself is overdue to surge much higher with the worst inflation since the 1970s raging. During that decade’s last couple inflation super-spikes, monthly-average gold prices from trough-to-peak CPI months skyrocketed. They nearly tripled during that first inflation super-spike, then more than quadrupled during the second! Much-higher gold prices inevitably coming will work wonders for gold miners’ fundamentals.

The bottom line is the mid-tier gold miners just reported a challenging quarter. Collectively they suffered an unusual number of individual-mine problems, driving down overall production. That combined with inflationary cost pressures on consumables catapulted mining costs to record highs, slashing profitability. But even with raised full-year cost guidances, mid-tiers are still forecasting lower costs in coming quarters.

They expect improving mine throughputs and higher ore grades will drive down costs, boosting earnings regardless of inflation. And gold itself is overdue to resume powering higher on big gold-futures mean-reversion buying and surging investment demand as inflation rages. That would supercharge gold-mining profits, positioning the battered mid-tiers’ stocks for enormous upside potential as sentiment shifts bullish.

(By Adam Hamilton)