Gold Miners’ Q3’17 Fundamentals

 

Adam Hamilton

 

The gold miners’ stocks have spent months adrift, cast off in the long shadow of the Trumphoria stock-market rally.  This vexing consolidation has left a wasteland of popular bearishness.  But once a quarter earnings season arrives, bright fundamental sunlight dispelling the obscuring sentiment fogs.  The major gold miners’ just-reported Q3’17 results prove this sector remains strong fundamentally, and super-undervalued.

 

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.  Canadian companies have similar requirements.  In other countries with half-year reporting, many companies still partially report quarterly.

 

The world’s major gold miners just wrapped up their third-quarter earnings season.  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.

 

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 23.2x larger than the next-biggest 1x-long major-gold-miners ETF!

 

Being included in GDX is the gold standard for gold miners, requiring deep analysis and vetting by elite analysts.  And due to ETF investing eclipsing individual-stock investing, major-ETF inclusion is one of the most-important considerations for picking great gold stocks.  As the vast pools of fund capital flow into leading ETFs, these ETFs in turn buy shares in their underlying companies bidding their stock prices higher.

 

This week GDX included a whopping 51 component “Gold Miners”.  That term is used somewhat loosely, as this ETF also contains major silver miners, silver streamers, and gold royalty companies.  Still, all the world’s major gold miners are GDX components.  Due to time constraints, I limited my deep individual-company research to this ETF’s top 34 components, an arbitrary number that fits neatly into the tables below.

 

Collectively GDX’s 34 largest components now account for 91.9% of its total weighting, a commanding sample.  GDX’s components include major foreign gold miners trading in Australia, the UK, and South Africa.  These companies report in half-year increments instead of quarterly, so their Q3 data is limited.  They usually publish quarterly production results, but generally don’t disclose quarterly financial results.

 

The importance of these top-GDX-component gold miners can’t be overstated.  In Q3 they collectively produced over 9.9m ounces of gold, or 309.4 metric tons.  The World Gold Council’s recently-released Q3 Gold Demand Trends report, the definitive source on worldwide supply-and-demand fundamentals, pegged total global mine production at 841.0t in Q3.  GDX’s top 34 miners alone accounted for nearly 4/10ths!

 

Every quarter I wade through a ton of data from these elite gold miners’ 10-Qs, and dump it into a big spreadsheet for analysis.  The highlights made it into these tables.  If a field is left blank, that means a company didn’t report that data for Q3’17 as of this Wednesday.  Companies always try to present their quarterly results in the best-possible light, which leads to wide variations in reporting styles and data offered.

 

In these tables the first couple columns show each GDX component’s symbol and weighting within this ETF as of this week.  While most 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 Q3’17 gold production in ounces, which is mostly reported in pure-gold terms.

 

Most 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 Q3’16.

 

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’s one key exception to these YoY changes.

 

Percentage changes aren’t relevant or meaningful if data shifted from positive to negative or vice versa.  Some major gold miners earning profits in Q3’16 suffered net losses in Q3’17.  So in cases where data crossed that zero line, I included the raw numbers instead.  This whole dataset offers a fantastic high-level fundamental read on how the major gold miners are faring today.  They’re actually doing quite well!

 

After spending days digesting these elite gold miners’ latest quarterly reports, it’s fully apparent their vexing consolidation this year isn’t fundamentally righteous at all!  Traders have abandoned this sector since the election 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!

 

 

 

 

Since gold miners are in the business of wresting gold from the bowels of the Earth, production is the best place to start.  The 9947k ounces of gold collectively produced last quarter by these elite major gold miners is up 0.5% YoY from Q3’16.  That’s relatively solid, as the World Gold Council’s supply data shows a 1.3% YoY drop in global gold mine production.  So the GDX majors effectively gained market share.

 

Yet on a sequential quarter-on-quarter basis, these top-34 GDX miners only grew production 0.9% from Q2’17.  That’s definitely disappointing.  The WGC reported world mine production grew 3.1% QoQ.  Even that is down sharply from the average 7.2% sequential growth between Q2s and Q3s from 2010 to 2016.  The major gold miners are collectively having a hard time expanding their production, which is bullish for gold.

 

Gold deposits economically viable to mine are very rare in the natural world, and the low-hanging fruit has largely been harvested.  It is growing ever more expensive to explore for gold, in far-less-hospitable places.  Then even after new deposits are discovered, it takes well over a decade to jump through all the Draconian regulatory hoops necessary to secure permitting.  And only then can mine construction finally start.

 

That takes additional years and hundreds of millions if not billions of dollars per gold mine.  But because gold-mining stocks have been deeply out of favor most of the time since 2013, capital has been heavily constrained.  When banks are bearish on gold prices they aren’t willing to lend to gold miners except with onerous terms.  And when investors aren’t buying gold stocks, issuing new shares low is heavily dilutive.

 

The large gold miners used to rely heavily on the smaller junior gold miners to explore and replenish the gold-production pipeline.  But juniors have been devastated since 2013, starved of capital.  Not only are investors completely uninterested with general stock markets levitating, but the rise of ETFs has funneled most investment inflows into a handful of larger-market-cap juniors while the rest see little meaningful buying.

 

So even the world’s biggest and best gold miners are struggling to grow production.  While that isn’t great for individual gold miners, it’s super-bullish for gold.  The less gold mined, the more gold supply will fail to keep pace with demand.  That will result in higher gold prices, making gold mining more profitable in the future.  Some analysts even think peak gold has been reached, that mine production will decline indefinitely.

 

There are strong fundamental arguments in favor of peak-gold theories.  But regardless of where overall global gold production heads in coming years, the major gold miners able to grow their own production will fare the best.  They’ll attract in relatively more investor capital, bidding their stocks to premium prices compared to peers who can’t grow production.  Stock picking is more important than ever in this ETF world!

 

But despite these top-34 GDX components’ abnormally-slow Q3’17 production growth, they remain quite strong fundamentally.  The viability of gold miners is measured by the difference between prevailing gold prices and what it costs to produce that gold.  Even with the average gold price falling significantly between Q3’16 and Q3’17, the major gold miners collectively remain very profitable.  Their costs are well under control.

 

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 Q3’17, these top-34 GDX-component gold miners that reported cash costs averaged just $591 per ounce.  That plunged a remarkable 8.8% YoY from Q3’16’s $648!  Production costs are falling.

 

Today the gold miners’ stocks are trading at crazy-low prices implying their survivability is in jeopardy.  This week the flagship HUI gold-stock index was languishing near 186, despite $1278 gold.  The first time the HUI hit 186 in August 2003, gold was only in the $360s!  Gold stocks are radically undervalued today by virtually every metric.  They collectively face zero threat of bankruptcies unless gold plummets under $600.

 

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 a gold mine as an ongoing concern.  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 Q3’17, these top-34 GDX-component gold miners reporting AISC averaged a level of just $868 per ounce.  That was up a slight 1.5% YoY and a trivial 0.1% QoQ, pretty much flat.  That AISC gold price is effectively this industry’s breakeven level.  As long as gold stays higher, the major gold miners can earn profits mining it indefinitely.  In spite of Q3’s lower gold prices, the major gold miners remained very profitable.

 

Gold’s $1279 average price in Q3’17 fell a significant 4.2% YoY from Q3’16’s $1334 average.  $56 lower gold prices definitely took a bite out of operating profits.  At $1279 gold and $868 AISC, GDX’s top 34 gold miners were collectively earning $411 per ounce last quarter!  That’s down 14.2% YoY from Q3’16’s $479 fueled by higher average gold prices and slightly-lower all-in sustaining costs.  But $411 is still hefty.

 

That implies fat 32% operating margins, levels most industries would kill for.  The serious bearishness in precious metals has led many investors to assume the gold miners must be struggling fundamentally.  But they are thriving with high-$1200s gold!  This metal would have to collapse under $900 before the long-term viability of today’s major gold miners would be called into question, which definitely isn’t in the cards.

 

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.

 

So gold-mining profits really leverage rising and falling gold prices.  Q3’17 experienced this on the downside, with a 4.2% drop in average gold prices leading to a 14.2% YoY operating-profit decline.  But this certainly doesn’t justify the sharply-lower gold-stock prices.  Average HUI levels plunged 22.5% from 255 in Q3’16 to just 197 in Q3’17.  The latest $411-per-ounce profits are already high, and are heading far higher.

 

Gold itself is overdue for a major new upleg driven by investment demand returning.  As I discussed in depth last week, investment demand has stalled thanks to the extreme stock-market euphoria.  These bubble-valued stock markets are due to roll over imminently as the Fed and European Central Bank both start aggressively choking off liquidity.  That will strangle this stock bull, reigniting big gold investment demand.

 

The impact of higher gold prices on major-gold-miner profitability is easy to model.  Assuming flat all-in sustaining costs at Q3’17’s $868 per ounce, 10%, 20%, and 30% gold rallies from this week’s levels will lead to collective gold-mining profits surging 31%, 62%, and 93%!  And another 30% gold upleg isn’t a stretch at all.  In essentially the first half of 2016 alone after the last stock-market correction, gold surged 29.9%.

 

The major gold stocks as measured by the HUI, which closely mirrors GDX, skyrocketed 182.2% higher in roughly that same span!  Gold-mining profits and thus gold-stock prices soar when gold is powering higher.  And incidentally Q3’17’s major-gold-miner AISC levels are overstated thanks to the South African gold miners.  They face serious political and operational problems as I discussed in my previous Q2’17 GDX essay.

 

Gold-mining costs are spiraling higher in South Africa as production fades due to both aging super-deep mines and government interference.  AngloGold Ashanti, Gold Fields, and Sibanye Gold have extensive South African exposure and thus higher AISC.  Pull those companies out of the average, and the major-gold-miner AISC falls to $846.  That’s closer to the true global gold production cost, around $850 per ounce.

 

The key takeaway for investors is the major gold miners are very profitable even at the lackluster high-$1200s gold prices of recent months.  Anything above $850 or so is pure profit, and those profits really amplify higher gold prices.  So the bearish-sentiment-fueled notion today that the major gold miners are struggling fundamentally is totally false.  Their low stock prices are the result of psychology, not operations.

 

While all-in sustaining costs are the single-most-important fundamental measure that investors need to keep an eye on, other metrics offer peripheral reads on the major gold miners’ fundamental health.  The more important ones include cash flows generated from operations, actual accounting profits, revenues, and cash on hand.  They generally corroborated AISC in Q3’17, proving the gold miners are faring quite well.

 

These top-34 GDX-component gold miners reporting operating cash flows for Q3 collectively generated $4.1b.  That’s down 28.5% YoY, which isn’t surprising given lower prevailing gold prices.  Interestingly OCF was still up 22.0% QoQ though, a big jump considering this gold-price environment.  Every one of these elite GDX gold miners reported positive OCF in Q3, with many results fairly large relative to market caps.


Within individual gold miners operating cash flows can vary considerably quarter to quarter depending on what they are doing with their operating gold mines.  As long as OCFs remain massively positive, the gold miners’ operations are quite profitable.  That certainly remained true as a sector in Q3’17 despite the lower prevailing gold price.  The other major-gold-miner accounting metrics remained much more stable YoY.

 

These top GDX gold miners’ GAAP accounting profits only retreated 6.6% YoY to $854m, which is really impressive considering the 4.2% lower average gold price.  While gold miners have struggled in the deep bearish psychology plaguing this sector since 2013, it has forced them to become ruthless in controlling their costs.  Thus a few of these elite gold miners are sporting super-cheap single-digit price-to-earnings ratios.

 

Sequentially quarter-on-quarter these major gold miners’ profits did plunge 64.0% from Q2’17’s, certainly sounding ominous.  But as I explained a quarter ago, Q2’s profits were artificially boosted by huge one-time gains from a couple companies selling interests in major gold projects and reversing impairment charges.  Such events are rare, but they have to be watched for since they can greatly skew accounting profits.

 

The revenues front was much less volatile, just as expected given the relatively-flat gold production.  The collective sales of these top 34 GDX components fell 5.2% YoY to $10.4b, right in line with Q3’17’s lower average gold prices.  Sales moved even less QoQ, merely retreating 2.6% from Q2.  Unlike most other industries, gold miners have no problem selling every single ounce of gold they can manage to produce.

 

The final metric for investors to watch is cash on balance sheets.  Having sufficient cash gives companies both flexibility in growing operations and financial resilience to weather unforeseen challenges.  The more cash gold miners have on hand, the more opportunities they have to acquire new projects and the greater their protection against individual-mine problems.  These top GDX gold miners reported $11.8b in Q3’17.

 

That was only down 6.6% YoY, proving operating-cash-flow generation was high.  Cash did drop 14.0% QoQ, but that’s not necessarily bad.  As long as gold miners are cash-flow positive, big drops in cash tend to come from expanding operations which will yield more future production.  Bringing new gold mines online or improving infrastructure at existing ones is very expensive, requiring big spending to execute.

 

Pretium Resources is a great example, having one of the worst cash showings in Q3’17.  Its total cash plummeted 69% YoY to $54m, which could be concerning without context.  But Pretium was spending big as planned to bring its amazing new Brucejack gold mine to commercial production right as Q3 was dawning.  Pretium went from a mere explorer building that mine a year ago to producing 82k ounces in Q3!

 

So overall the major gold miners’ fundamentals looked quite impressive in Q3’17, a stark contrast to the miserable sentiment plaguing this sector.  Gold stocks’ vexing consolidation this year wasn’t the result of operational struggles, but purely bearish psychology.  That will soon shift as the stock markets roll over and gold surges, making the beaten-down gold stocks a coiled spring today.  They are overdue to soar again!

 

Though this contrarian sector is widely despised now, it was the best-performing in all the stock markets last year despite that sharp post-election selloff in Q4.  The HUI blasted 64.0% higher in 2016, trouncing the S&P 500’s mere 9.5% gain!  Similar huge 50%+ gold-stock gains are likely again in 2018, as gold mean reverts higher on the coming stock-market selloff.  The gold miners’ strong Q3 fundamentals prove this.

 

While investors and speculators alike can certainly play gold stocks’ coming rebound rally 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 bottom line is the major gold miners’ fundamentals remained quite strong in the just-reported third quarter.  Slight production growth coupled with stable costs helped offset some of gold’s decline from the same quarter a year earlier.  The gold miners continued to earn hefty operating profits while generating good cash flows.  Sooner or later investors will take notice of this forgotten sector’s strong fundamentals.

 

The universally-despised gold stocks are the last dirt-cheap sector in these Trumphoria-inflated stock markets.  No one wants anything to do with them, which is the best time to buy low before they soar.  All it will take to ignite gold stocks’ overdue mean-reversion rally is gold investment demand returning.  The miners’ profits will really leverage gold rallying higher, making gold stocks even more fundamentally compelling.

 

Adam Hamilton, CPA

 

 

 

 

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