Gold miners’ Q2’18 fundamentals

The definitive list of major gold-mining stocks to analyze comes from the world’s most-popular gold-stock investment vehicle, the GDX VanEck Vectors Gold Miners ETF.  Its composition and performance are similar to the benchmark HUI gold-stock index.  GDX utterly dominates this sector, with no meaningful competition.  This week GDX’s net assets are 33.4x larger than the next-biggest 1x-long major-gold-miners ETF!

GDX is effectively the gold-mining industry’s blue-chip index, including the biggest and best publicly-traded gold miners from around the globe.  GDX inclusion is not only prestigious, but grants gold miners better access to the vast pools of stock-market capital.  As ETF investing continues to rise, capital inflows into leading sector ETFs require their managers to buy more shares in underlying component companies.

GDX’s component list this week ran 49 “Gold Miners” long.  While the great majority of GDX stocks do fit that bill, it also contains gold-royalty companies and major silver miners.  All the world’s big primary gold miners publicly traded in major markets are included.  Every quarter I look into the latest operating and financial results of the top 34 GDX companies, which is just an arbitrary number fitting neatly into these tables.

That’s a commanding sample, as GDX’s 34 largest components now account for a whopping 91.7% of its total weighting!  These elite miners that reported Q2’18 results produced 241.0 metric tons of gold, which accounts for fully 28.8% of last quarter’s total global gold production.  That ran 835.5t per the recently-released Q2’18 Gold Demand Trends report from the World Gold Council.  I’ll discuss production more below.

Most of these top 34 GDX gold miners trade in the US and Canada where comprehensive quarterly reporting is required by regulators.  But some trade in Australia and the UK, where companies just need to report in half-year increments.  Fortunately those gold miners do still tend to issue production reports without financial statements each quarter.  There are still wide variations in reporting styles and data offered.

Every quarter I wade through a ton of data from these elite gold miners’ latest results and dump it into a big spreadsheet for analysis.  The highlights make it into these tables.  Blank fields mean a company had not reported that data for Q2’18 as of this Wednesday.  Looking at the major gold miners’ latest results in aggregate offers valuable insights on this industry’s current fundamental health unrivaled anywhere else.

The first couple columns of these tables show each GDX component’s symbol and weighting within this ETF as of this week.  While most of these stocks trade on US exchanges, some symbols are listings from companies’ primary foreign stock exchanges.  That’s followed by each gold miner’s Q2’18 production in ounces, which is mostly in pure-gold terms.  That excludes byproduct metals often present in gold ore.

Those are usually silver and base metals like copper, which are valuable.  They are sold to offset some of the considerable costs of gold mining, lowering per-ounce costs and thus raising overall profitability.  In cases where companies didn’t separate out gold and lumped all production into gold-equivalent ounces, those GEOs are included instead.  Then production’s absolute year-over-year change from Q2’17 is shown.

Next comes gold miners’ most-important fundamental data for investors, cash costs and all-in sustaining costs per ounce mined.  The latter directly drives profitability which ultimately determines stock prices.  These key costs are also followed by YoY changes.  Last but not least the annual changes are shown in operating cash flows generated, hard GAAP earnings, sales, and cash on hand with a couple exceptions.

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 data rather than weird or misleading percentage changes.  This whole dataset together offers a fantastic high-level read on how the major gold miners are faring fundamentally as an industry.  Was this week’s plummeting righteous?

This ongoing quarterly post-earnings-season project to better understand how the gold-mining industry is actually faring fundamentally is tedious and time-consuming.  The best insights don’t emerge until all the research is complete, as the big picture is more illuminating than individual companies’ results.  As I was doing much of this work this week, the plummeting gold-stock prices cast a dark psychological pall over everything.

I always start at the top of GDX’s component list and gradually work my way down, examining the latest quarterly filings from each company.  Early on I was shocked by the sharp annual production declines at the world’s biggest gold miners!  Newmont Mining and Barrick Gold have run neck-and-neck as the top gold miners for long decades now.  Compared to most other gold miners, their resources may as well be unlimited.

They have diversified portfolios of gold mines across continents and many countries, and deep pipelines of exploration projects and new-mine builds.  NEM and ABX pour vast amounts of capital into maintaining their gold production as existing mines are depleted.  The major gold miners hate reporting declines in production, as investors punish stocks for it with sizable selling.  It is seen as signaling deteriorating health.

So gold miners suffering production drops often intentionally obscure it by omitting normal year-over-year comparisons from their press releases announcing quarterly results.  They don’t present the tables with the current quarter next to the comparable prior-year quarter like they do when production is growing.  It feels like a game of misdirection, emphasizing other metrics while forcing investors to dig deeper for that data.

The bigger the gold miners, the more opportunities they have to make up production shortfalls at some of their mines from other mines in their portfolios.  So it was stunning to see NEM report its Q2’18 production plunging 14.1% YoY.  And ABX’s was much worse, plummeting a catastrophic 25.5% YoY!  That ominous trend infected other top gold miners too.  Goldcorp mined 10.1% less gold in Q2’18 than it did a year earlier.

Kinross Gold’s production fell 13.4% YoY.  Together these 4 elite major gold miners account for almost a quarter of GDX’s total weighting!  How on earth can their total production plunge 17.3% from 4.1m ounces in Q2’17 to 3.4m ounces in Q2’18?  That was actually contrary to the gold-mining industry as a whole.  Again according to that latest WGC GDT, overall world mine production grew 3.0% YoY from Q2’17 to Q2’18.

The excuses given are nothing new to gold-mining investors, primarily lower-grade ore processed along with geological and geopolitical challenges at various individual mines.  Wresting gold from the bowels of the earth in remote locations is never easy, as all the low-hanging fruit has long since been mined.  With even the biggest and the best gold miners failing to maintain production, peak-gold theories are bolstered.

Incredibly as a whole, these top 34 GDX gold miners responsible for well over a quarter of the total world gold mined in Q2 saw their overall production plummet 20.9% YoY to 7.7m ounces!  That’s skewed though, as two major South African gold miners had reported their Q2’17 production a year ago this week but had yet to disclose Q2’18 production as of Wednesday’s data cutoff for this essay.  They chose not to do it this year.

AngloGold Ashanti and Gold Fields report in half-year increments, so they have no obligation to separate out quarters.  I wonder if the reason they did last year but not this year is to mask slowing production.  If their H1’18 results are divided by two, they would’ve added another 789k and 497k ounces.  But that still leaves GDX’s top 34 miners with collective gold production down a sharp 7.7% YoY, way worse than the industry.

While Q2’18’s underperformance by the biggest gold miners dominating GDX and the HUI was striking, it is nothing new.  That’s why I’ve long recommended investors avoid many of the largest gold miners.  Mid-tier miners with growing production as they bring new mines online and much-smaller market caps have far-greater upside potential during gold uplegs.  They are bucking the increasingly-evident peak-gold predicament.

Gold deposits economically viable to mine are very rare in the natural world, and getting much harder to find after centuries of exploration.  It is growing ever more expensive to explore for gold, in places that are getting less hospitable with every passing year.  Even after new deposits are discovered, jumping through all the Draconian regulatory hoops necessary to secure permitting for construction can take another decade.

Building the gold mines takes additional years and hundreds of millions if not billions of dollars each!  This industry normally has enough capital to invest in replenishing depleting production.  But ever since 2013 when gold plunged on extreme central-bank machinations, the gold miners have been heavily starved of necessary capital.  So their new-production pipeline has inexorably withered away to a shadow of its former self.

As long as gold stocks remain deeply out of favor among investors because gold prices are so low, this supply deterioration will continue if not accelerate.  But even if gold doubled or tripled today and stayed high for years, it would still take well over a decade for world mined supply to adjust.  Some top mining CEOs and analysts believe we are seeing peak gold, that production will keep declining regardless of gold prices.

Peak gold is likely bearish for the largest gold miners that drive GDX and the HUI.  Capital inflows from investors will wane along with their production.  But lower gold mined supply on balance going forward is wildly bullish for the mid-tier and junior gold miners growing their production!  The resulting higher gold prices will catapult their profits and thus stock prices higher, attracting in investors fleeing the struggling majors.

The only way to reap these massive gains is directly investing in the best individual gold miners.  Their fundamentals are far superior to their sector as a whole.  While buying GDX is easy, the lion’s share of that capital is funneled into the major gold miners with slowing production.  Their underperformance will dilute away any outperformance among mid-tier miners in this ETF, leading to mediocre overall gains.

One key reason slowing production is bad for gold miners is it usually leads to proportionally-higher costs.  Again in Q2’18 NEM’s production fell 14.1% YoY, so its all-in sustaining costs rose a symmetrical 15.8% YoY.  ABX’s colossal 25.5% production drop fueled 20.6% higher AISCs.  And KGC’s 13.4% lower gold production last quarter forced its AISCs 11.9% higher.  Higher mining costs naturally drive profits lower.

With major gold miners’ production falling sharply, their costs of mining should be proportionally higher.  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.  Little changes in throughput terms.

The mills processing the gold-bearing ore and inevitable accompanying waste rock have hard limits to tonnages they can chew through.  When richer ore is processed, more ounces of gold are produced to spread the big fixed costs across.  But when mine managers have to dig through lower-grade ore, either on the way to higher-grade stuff later or in depleting mines, fewer ounces of gold must bear the full cost burden.

So as I started digging through the top 34 GDX components’ Q2 results, I expected to see the major gold miners’ collective AISCs rise due to lower production.  That’s certainly bearish fundamentally, portending lower profits that could justify some of the brutal gold-stock selling this summer.  But as a whole, rather amazingly these elite gold miners held the line on costs!  The top majors’ rises were offset by other miners.

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 Q2’18, these top 34 GDX-component gold miners that reported cash costs averaged $610 per ounce.  That was merely up 0.8% YoY from Q2’17, rather remarkable considering the lower production!

The capitulation-grade gold-stock selling this week was horrendous, with GDX plummeting 9.5% in just 3 trading days ending Wednesday.  This leading gold-stock ETF plunged to $18.60 per share, shattering its major $21 support that had held strong through five major challenges since the dawn of 2017.  Down a dreadful 20.0% year-to-date, GDX was trading at a miserable 2.5-year low on cascading stop-loss selling.

But with cash costs averaging $610 per ounce, the major gold miners are certainly in no fundamental peril!  While gold somehow managed to plunge 2.9% in those same few trading days despite crazy-all-time-record spec gold-futures shorts, it was still near $1176.  The gold stocks face no existential threat as long as gold prices remain far above the cash costs of mining it.  There’s nothing to fear fundamentally this week.

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.  AISCs 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.

With the top 34 GDX gold miners’ Q2’18 production down 20.9% YoY or even 7.7% if that implied South African production is added in, I would’ve bet their AISCs would’ve surged proportionally.  Yet incredibly they actually slipped 1.3% YoY to just $856 per ounce!  This was no anomaly either, as the top 34 GDX miners’ AISCs have averaged $867, $868, $858, and $884 over the past four quarters.  Q2’18’s were in trend.

The fundamental implications of this are very bullish, proving that this week’s gold-stock capitulation was purely an overdone herd-sentiment thing.  Gold averaged $1306 in Q2’18, up 3.9% YoY.  That means the elite major gold miners were earning average profits just under $450 per ounce.  Thanks to the slightly-lower AISCs and modestly-higher gold price, those earnings rose 15.2% YoY from the $390 per ounce in Q2’17.

With gold mining a heck of a lot more profitable last quarter than a year earlier, you’d think the gold-stock prices would’ve been proportionally higher.  Yet GDX’s average price last quarter was 1.5% lower YoY.  That makes zero sense fundamentally.  And even if this week’s capitulation-grade $1175 gold was able to magically persist as if those crazy-record gold-futures shorts were never covered, gold mining is still very profitable.

At Q2’18’s average AISCs which are again exactly in line with recent years’ levels, $1175 gold would still yield hefty $319-per-ounce profits for the major gold miners.  That number is quite provocative.  This Wednesday the flagship HUI gold-stock index plunged to 143.3 on that cascading-stop-loss selling, a deep 2.5-year low.  But the first time the HUI ever hit this week’s levels was way back in May 2002, 16.2 years ago!

Then gold was trading near $326, which was its best levels of its young secular bull at that point.  Think about this absurd fundamental disconnect.  Today’s gold-stock prices were first seen way back when the entire gold price was about the same level as today’s absolute profitability alone!  That is just ridiculous, highlighting the extreme undervaluation in gold stocks.  Their crazy-low stock prices are an extreme anomaly.

Should a sector running hefty 27% profit margins even at $1175 gold be trading this week at price levels first seen when gold was 72% lower?  Hell no!  Similar past capitulation-like anomalies have led to huge subsequent mean-reversion-rebound gains.  During 2008’s stock panic, the HUI fell as low as 151.6 in response to $720 gold.  Those were higher gold-stock prices than this week despite gold being 38% lower!

Just like this week, back in October 2008 fear was extreme as investors fled gold stocks.  They foolishly assumed extreme gold and gold-stock declines could persist indefinitely rather than quickly burning themselves out.  So the traders who couldn’t get past their own herd-driven emotions sold at the bottom.  They unfortunately missed the HUI more than quadrupling over the next 2.9 years with a major 319.0% bull run!

As long as the gold miners can produce gold at all-in sustaining costs way below prevailing gold prices, they will generate big profits for investors.  Eventually their stock-price levels have to reflect their true underlying profitability.  With $1175ish gold and $856 AISCs, the gold miners’ stock prices must rebound radically higher.  Their extreme low levels today are fundamentally absurd, they can’t and won’t last for long.

The rest of the top 34 GDX gold miners’ core fundamentals in Q2’18 reflected their lower year-over-year production.  Their overall cash flows generated from operations fell 18.3% YoY to $2747m.  That’s not out of line considering the 7.2% decrease in sales to $9993m due to less gold mined.  Interestingly in addition to mining 20.9% less gold YoY excluding those non-reporting South African miners, silver production fell more.

GDX has plenty of major silver miners among its ranks, as the pool of major gold miners is fairly small.  Silver is much less profitable to mine than gold at current depressed price levels, so traditional big silver miners are increasingly investing in diversifying into gold mining.  The top 34 GDX components’ overall silver production plummeted 32.4% YoY to 29.1m ounces in Q2’18!  That helped sales fall despite higher gold prices.

These top 34 GDX gold miners’ total GAAP accounting profits reported to regulators looked like a disaster in Q2’18.  They cratered 66.2% YoY to $802m!  But that’s very misleading, as one-off charges and gains flowing through to miners’ bottom lines can greatly distort headline profitability.  There were a couple massive non-recurring gains in Q2’17 results that I discussed a year ago that artificially boosted those profits.

Back then Barrick Gold reported an enormous $880m gain selling half and quarter interests in a couple major gold projects in Argentina and Chile.  And IAMGOLD reversed impairment charges to report a huge $524m non-cash gain.  Removing just these two unusual items alone from overall Q2’17 profits recasts Q2’18’s decline as a far-milder 17.1% YoY.  That’s about what you’d expect with sales sliding 7.2% in that span.

While not included in this table, the average trailing-twelve-month price-to-earnings ratios of these major gold miners declined 2.2% YoY to 38.0x.  And that number is skewed way high by a few outliers, as there are plenty of top 34 GDX gold miners trading at cheap TTM P/Es in the low double digits or even single digits this week.  The gold miners’ earnings are fine, and don’t remotely justify this week’s capitulation-like plunge.

Another fundamental metric for gold miners’ health is their cash balances.  Despite the lower production and sales in Q2’18, these top 34 GDX components exited it with $12.4b of cash on their balance sheets.  That provides a huge buffer to weather lower gold, and gives them enough capital firepower to expand existing mines and build or buy new ones to help offset declining production.  That was only down 9.6% YoY.

If your view on gold-mining stocks is solely based on their price levels, you’re probably convinced they are doomed after this week’s plunge.  Everyone freaked out as they got sucked into anomalous gold selling which triggered all kinds of involuntary stop-loss selling.  This definitely wasn’t the first time this sector was hammered by fearful herd psychology, and certainly won’t be the last.  But such extreme anomalies soon reverse.

While sentiment is devastated, the major gold miners’ underlying fundamentals remain strong.  They are struggling with shrinking production overall, but their mining costs still remain far below prevailing gold prices still driving strong profitability.  While sales reflect fewer ounces mined, they are still generating big operating cash flows and earnings.  Today’s gold-stock price levels are ludicrous relative to their fundamentals!

So a big mean-reversion rebound higher is inevitable and imminent.  While traders can play that in GDX, that is mostly a bet on the largest gold miners with slowing production.  The best gains by far will be won in smaller mid-tier and junior gold miners with superior fundamentals.  A carefully-handpicked portfolio of elite gold and silver miners will generate much-greater wealth creation than ETFs dominated by underperformers.

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The bottom line is the major gold miners’ fundamentals are quite strong based on their recently-reported Q2’18 results.  While production declined sharply, these miners still held the line on all-in sustaining costs.  That fueled fat operating profits and strong cash flows.  These will only grow as gold rebounds on record futures short covering.  Many miners are forecasting improving H2’18 production as well on higher-grade ore.

Yet gold stocks are priced today as if they are doomed to spiral lower forever.  That’s truly fundamentally absurd given their strong profits even at this week’s battered gold levels.  Traders need to look through this frightened herd sentiment to understand these anomalous gold-stock prices soon have to mean revert radically higher.  It’s hard staying long while everyone else is scared, but that’s when big gains are won.