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Adam Hamilton

Adam Hamilton

Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis of markets, geopolitics, economics, finance, and investing…

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Gold Miners’ Q2’17 Fundamentals

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 Q2’17 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, some companies still partially report quarterly.

The world’s major gold miners just wrapped up their second-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 19.9x 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 50 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 great 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 92.1% of its total weighting, a commanding sample.  While the vast majority of gold miners’ Q2’17 results have been released, a few are still coming due to later reporting.  GDX includes major foreign gold miners trading in Australia, the UK, and South Africa.  These companies report in half-year increments instead of quarterly, so their Q2 data is limited.

The importance of these top-GDX-component gold miners can’t be overstated.  In Q2 they collectively produced nearly 9.9m ounces of gold, or 306.5 metric tons.  The World Gold Council’s recently-released Q2 Gold Demand Trends report, the definitive source on worldwide supply-and-demand fundamentals, pegged total global mine production at 791.2t in Q2.  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 Q2’17 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 Q2’17 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 Q2’16.

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 negative to positive or vice versa.  Plenty of major gold miners earning profits in Q2’17 suffered net losses in Q2’16.  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 doing pretty darned 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!

The elite ranks of the world’s top gold miners haven’t changed much in the past year, seeing only slight shuffling in their GDX weightings.  All the usual suspects are here.  Since gold miners are in the business of wresting gold from the bowels of the Earth, production is the best place to start.  These top 34 GDX gold miners again collectively produced 9,854k ounces in Q2’17.  That merely rose 0.5% YoY, essentially flat.

That’s misleading though.  GDX’s indexers have long loved the South African gold miners, despite them suffering ongoing heavy depredation by one of the world’s most corrupt and racist governments.  Back in 2004, the South African government mandated gold miners increase their black ownership to 26% over the next decade.  That was largely accomplished by diluting existing shareholders to give to new ones.

Many of these new black owners soon sold their share windfalls, which forced the unconscionable racial quota lower.  Just in mid-June, South African stocks were crushed after their government declared a new black-ownership target of 30%.  Even if miners had already hit that previous 26% racial quota, they were given just one year to top back up to 30%.  So the entire South African mining industry is reeling in disarray.

Foreign investors being discriminated against for their skin color are fleeing in droves.  The South African miners are under so much pressure they are delaying their financial reporting.  This week Sibanye Gold was GDX’s 15th-largest holding, and it hadn’t even reported Q2’17 gold production yet.  In Q1’17 it ran 330k ounces.  So assuming that holds, the top 34 GDX components’ Q2 production is actually running 10,184k ounces.

That makes for impressive 3.9% YoY growth!  That latest World Gold Council data shows global mined gold supply slipped 0.3% YoY in Q2.  So the major gold miners are using their superior capital firepower to take gold-mining market share from smaller miners.  Given the South African government’s openly-racist policies hostile to current shareholders, GDX’s managers should boot all the South African miners from this ETF.

Back in mid-May when I published my analysis of the major gold miners’ Q1’17 results, I discussed an interesting seasonal phenomenon.  Between 2011 and 2016, world gold production dropped 8.4% on average from Q4s to Q1s.  The drivers of this were explained back in that essay.  The relevant part today is that global gold production bounces back dramatically in Q2s and Q3s following those Q1 slumps.

That indeed came to pass again this year despite the lackluster gold-price environment in Q2’17.  With that assumed Sibanye Gold Q2 production thrown in, the top 34 GDX gold miners’ Q2 production surged 5.5% quarter-on-quarter from Q1!  That’s in line with global gold production’s 6.3% average gain between these two quarters from 2011 to 2016.  Everything looks good on the major gold miners’ production front.

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, fuel, 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.

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 Q2’17, these top 34 GDX-component gold miners that reported cash costs averaged just $605 per ounce.  That was indeed down a sizable 1.9% YoY from Q2’16, and 2.9% QoQ from Q1’17.

Gold-stock traders are notoriously excitable.  Literally everything scares them, the sky is always falling in their worlds.  They collectively have little courage in their convictions, always looking for excuses to flee.  If they want something real to fear, it’s gold falling below the cash costs of mining it.  And at $605 in Q2, that true fundamental disaster isn’t in the cards.  Gold miners face no meaningful threats at today’s gold prices!

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 Q2’17, these top 34 GDX-component gold miners reporting AISC averaged a level of just $867 per ounce.  That’s down 2.1% YoY and 1.3% QoQ.  That gold price is effectively this industry’s breakeven level.  As long as gold is higher, the major gold miners can collectively earn profits mining.  And earnings were already hefty in Q2, with gold’s average price of $1258 remaining $391 above the prevailing AISC levels.

Even today with gold investment demand in tatters thanks to the extreme Trumphoria stock-market rally since the election, the gold miners are thriving.  The $391 per ounce they earned on average last quarter was a whopping 14.3% higher than their average profits of $342 in Q1’17.  Yet the average gold price only rallied 3.1% QoQ.  Thus the major gold miners enjoyed outstanding profits leverage to gold of 4.7x!

Yet you sure wouldn’t know it from gold-stock prices.  That leading HUI gold-stock index which is closely mirrored by GDX saw its average level actually fall 3.1% QoQ in Q2’17.  Despite gold miners’ earnings soaring dramatically, gold-stock prices slumped.  That proves the gold-stock weakness in Q2 was purely a sentiment thing, it was totally unjustified fundamentally.  Today’s low gold-stock prices are an anomaly.

Gold-stock price levels and psychology are totally dependent on gold, the dominant driver of miners’ profits.  As these bubble stock markets inevitably roll over, probably soon with the Fed’s quantitative tightening looming, gold investment will return to favor for prudent portfolio diversification.  And once gold rallies long enough and high enough to convince traders its strength is sustainable, gold stocks will be off to the races.

The key fundamental reason gold stocks enjoy such massive upside is their profits leverage to gold.  Gold-mining costs are essentially fixed during mine-planning stages, when engineers decide which ore bodies to mine, how to dig to them, and how to process that ore.  Quarter after quarter, generally the same numbers of employees, haul trucks, excavators, and mills are used regardless of prevailing gold prices.

So higher gold prices flow right through to the bottom line, costs don’t rise with them.  If gold rallies just another 3.4% from Q2’s average prices to average $1300 in a coming quarter, profits will surge another 10.7% at Q2’s all-in sustaining costs.  In a $1400-average-gold quarter, merely 11.3% higher from Q2’s levels, gold-mining profits would soar 36.3% higher.  At $1500, those gains surge to 19.3% and 61.9%!

And a 20% gold rally from Q2’s levels is nothing special.  Back in roughly the first half of last year after a sharp stock-market correction, gold powered 29.9% higher in just 6.7 months!  So if you believe gold is heading higher in coming quarters as these crazy stock markets falter, the gold stocks are screaming buys today fundamentally.  Their already-strong profitability will soar, amplifying gold’s mean-reversion upleg.

Another key measure of gold miners’ fundamental health is their cash flows generated from operations.  With Q2’s average gold price only 0.1% lower YoY, and AISC down 2.1%, I expected to see OCF growth last quarter.  But it didn’t happen, as these top 34 GDX components reporting Q2 cash flows generated from operations only totaled $3362m.  That was down a sharp 17.0% YoY, raining on gold stocks’ Q2 parade.

Of the 29 of the top 34 GDX components reporting Q2 OCFs, a majority 17 were down YoY.  I looked at this on a company-by-company basis, but no industry-wide trends jumped out.  Operating cashflows can vary considerably from quarter to quarter depending on what companies are doing with their operating gold mines.  As long as OCFs remain massively positive, the gold miners’ operations are quite profitable.

Between Q1’17 and Q2’17 when average gold prices only climbed 3.1%, the top GDX components’ OCF still surged 11.0% sequentially!  So the major gold miners are faring quite well despite all the excessively-bearish psychology arrayed against them.  Their GAAP-accounting-profits growth in Q2’17 was nothing short of spectacular, which will directly translate into lower price-to-earnings ratios to entice investors back.

The 25 of these top 34 GDX component gold miners reporting Q2 profits earned $2371m.  That was a mind-boggling 757% higher YoY!  Some of this collective growth wasn’t normal.  GDX’s largest component and the world’s largest gold miner is Barrick Gold.  In Q2 it reported an enormous gain of $880m on one-time sales of one-half and one-fourth of its interests in a couple major gold projects in Argentina and Chile.

IAMGOLD was another notable outlier, with a colossal $524m gain from reversing impairment charges.  But even without these two huge one-off gains, overall GAAP profits for these top 34 GDX gold miners that reported Q2 still soared 250% higher YoY!  Note in these tables how most of the miners saw substantial profits growth in Q2, with lots of green and little red in that column.  The swings across zero are telling too.

More miners swung from losses a year ago to profits in Q2’17 than the other way around.  Again all this profits growth will really bring down prevailing gold-mining price-to-earnings ratios, making this sector look a lot more attractive by that popular fundamental valuation measure.  Based on this year’s dismal gold-stock sentiment you’d think these miners were doing terribly, but the opposite proved true again in Q2.

With higher production most of these elite gold miners enjoyed sales growth too, but overall revenues in the top 34 GDX components reporting them last quarter still slipped 2.1% lower YoY.  There were two drivers.  This year’s Q2’17 results had 27 of these 34 companies report sales compared to 28 a year ago.  And these gold miners collectively saw a sharp 8.7% YoY drop in their silver production, weighing on revenues.

Still the $10.7b in collective sales among these top gold miners last quarter is up 3.9% QoQ, in line with the average gold-price gain of 3.1%.  Those sales are impressive for gold mining, but serve to reveal just how small this little contrarian sector remains.  It only takes a tiny fraction of stock-market capital to slosh into the gold miners’ stocks to fuel enormous gains fast.  Gold rallying is the key, which shifts sentiment to bullish.

Finally these top 34 GDX gold miners saw big gains in the cash on their balance sheets in Q2.  Weighing in at a hefty $13.7b, it surged 14.1% YoY.  The sales of major mining projects likely weren’t a big factor, as most sellers and buyers are in this top-GDX-component list.  Overall cash grew 3.5% or $462m QoQ, leaving the major gold miners with lots of firepower to snatch up promising projects and mines from the juniors.

So overall the major gold miners’ fundamentals looked quite impressive in Q2’17, 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 today, 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 possible again this year, as gold mean reverts higher on the coming stock-market selloff.  The gold miners’ strong Q2 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 were very strong in the just-reported second quarter.  Production growth drove lower costs, which along with rallying gold prices really helped catapult profits radically higher.  This is translating into falling P/E ratios, emphasizing the extreme undervaluation rampant in this deeply-out-of-favor sector.  Sooner or later investors will take notice and start returning en masse.

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.

By Adam Hamilton

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