Gold Juniorsí Q3í16 Fundamentals
Adam Hamilton December 2, 2016 3055 Words
The junior gold minersí and explorersí stocks have been crushed in recent months, collateral damage from enormous gold-futures selling. Thatís naturally left investors and speculators extremely bearish on gold juniors. But lost in all this technical and sentimental tumult are important fundamentals from the juniorsí recently-reported third-quarter financial and operational results, which proved quite strong and bullish.
The junior gold stocks are rightfully considered the Wild West of the gold sector. Most of the hundreds and hundreds of these small companies wonít prove successful. They wonít be able to secure funding to explore sufficiently, wonít be fortunate enough to find an economic deposit of gold to mine, or wonít be able to make the herculean leap from explorer to miner. The odds are stacked heavily against the gold juniors.
Nevertheless, the elite small gold explorers and miners able to overcome and grow their businesses to larger scales will see truly-enormous stock-price gains. The gold juniors are exceedingly important for the entire gold-mining industry, since they feed the critical gold-supply pipeline with new deposits and mines to offset the inexorable industry-wide depletion of current operations. Success here is radically rewarded.
Some of the worldís best junior gold miners and explorers are included in the GDXJ VanEck Vectors Junior Gold Miners ETF, this sectorís leading benchmark. Born in November 2009, GDXJ is the worldís second-largest gold-stock ETF after its big brother GDX which tracks the larger major gold miners. As of the middle of this week, GDXJís net assets ran about 4/10ths of GDXís. That testifies to junior goldsí popularity.
Unfortunately GDXJ has plunged in recent months in the massive gold-stock correction fueled by heavy gold-futures selling. After peaking in early August, GDXJ dropped by as much as 34.7% over 3.5 months as of late November. Thatís why junior gold stocks are so deeply out of favor today, universally feared, despised, or ignored. But context is essential to overcome the dangerous greed and fear that taint perceptions.
Before this latest massive correction, GDXJ skyrocketed 201.8% in just 6.7 months! So smart contrarian investors and speculators who were able to overcome the popular fear the last time juniors were deeply out of favor in mid-January tripled their capital. Even at the recent dismal correction lows, GDXJ was still up 75.7% year-to-date. So rather than fearing these high-flying stocks, traders should be salivating at their lows!
Unfortunately the gold juniorsí ugly massive-correction technicals and miserable sentiment are distracting traders from these companiesí far-more-important fundamentals. Exceptionally-weak stock prices and extremely-bearish psychology are always fleeting and short-lived. Itís the core fundamentals, how the gold juniors are actually faring operationally, that will govern their stocksí performances going forward.
In the US and Canada, publicly-traded companies are required to report their results to investors and regulators four times a year. In normal quarters that donít end fiscal years, these reports are due 45 days after quarter-ends. That means November 14th for Q3, so the junior gold minersí quarterly reports are fully released. They reveal hard fundamental reality, which dispels the emotional sentiment clouding perceptions.
After starting first with analyzing the Q3 results from the major gold miners of GDX, then moving on to the silver miners of SIL, this week Iím concluding my usual quarterly-results trilogy with the juniors of GDXJ. As of mid-November when these companies finished reporting their Q3s, GDXJ contained a whopping 46 component companies. I dug deeply into the top 34, a number which fits neatly into these tables.
These 34 largest GDXJ components collectively accounted for a commanding 91.9% of this ETFís total weighting. Unfortunately not all of these companies reported Q3 results. GDXJ includes gold stocks trading in Australia and Hong Kong, where financial reporting is only required in half-year increments. So those companies skip Q1s and Q3s, although they do often provide production updates which are helpful.
I waded through all available quarterly reports and fed the data into a spreadsheet, some of which made it into these tables. If a field is blank, that means a company didnít report that data for Q3. The foreign half-year reporters aside, different types of gold juniors report different data. Exploration companies have no production or sales for example, while royalty companies donít report normal mining expenses.
The first couple columns show each GDXJ componentís symbol and weighting in this ETF as of mid-November. Realize not all these symbols trade in the US. Each componentís primary listing is shown, which is on its home countryís stock exchange. Most of the non-US stocks in GDXJ trade in Canada or Australia. Thatís actually one of the big draws of GDXJ for American investors, exposure to foreign gold juniors.
Thatís followed by each companyís Q3í16 gold production, in pure-gold terms whenever available. But some GDXJ components lump in silver as gold-equivalent ounces so the gold canít be broken out. The quarter-on-quarter change in production, the absolute percentage difference between Q2í16 and Q3í16, is shown. QoQ changes are also included for all the rest of the data in these tables, illuminating trends.
I think quarter-on-quarter comparisons are more relevant at this point than year-over-year ones, because 2016 has proven a strong bull year for gold stocks while 2015 was a brutal bear year. Sectors behave very differently in bulls and bears, rendering them not comparable in many ways. Once this gold-stock bull transitions into its second year in 2017, conventional YoY analysis for the juniors will be more meaningful.
Next comes the GDXJ gold juniorsí crucial per-ounce cost data, in both cash-cost and all-in-sustaining-cost terms. Finally the Q3 cash flows generated from operations and actual quarterly accounting profits are shown. The former is the best proxy for how the gold miners are currently faring, among their most-important fundamental tells. The gold juniorsí Q3 reports collectively reveal how this industry is really doing.
GDXJís managers have always made some strange decisions regarding which stocks they include as components. Just a quarter ago in Q2 for example, a major silver miner actually had one of the highest weightings in this ďJunior Gold Miners ETFĒ. That was thankfully cleaned up after my Q2í16 analysis a few months ago, making GDXJ a purer gold-junior play. But something new and perplexing has arisen.
For weeks now if not longer, one of GDXJís top components has actually been the GDX major-gold-miners ETF! This decision is dumbfounding. Investors arenít buying GDXJ because they want major exposure, they would buy GDX for that. They are expecting to own junior gold miners like GDXJ advertises. So itís really lazy GDXJís managers chose to include GDX as a top component regardless of the reason.
GDX never shouldíve been even a temporary placeholder in GDXJ. If GDXJís managers had to remove a top component for some reason, they shouldíve just shifted up all the component weightings that were underneath it. With 46 component companies, removing one isnít even material. I have no idea why GDX has been a major GDXJ component at all, let alone for so long. It impugns this ETFís selection credibility.
While thereís no universal definition of what production levels define junior gold miners, GDXJ includes some components that are definitely not juniors. After decades of analyzing and trading gold stocks, Iíd suggest a cutoff somewhere around 300k ounces annually. Anything under is a junior, while anything larger is a mid-tier producer up to 1000k ounces. Across that threshold is the big league of the major miners.
Out of GDXJís top 34 component companies in mid-November, fully 10 produced over the 75k ounces quarterly in Q3 that could reasonably be considered junior territory. Overall production for these leading GDXJ gold miners ran 1974k ounces in Q3, 1/5th of the 9898k mined by the much-larger major miners of GDX last quarter. Overall top-34-component GDXJ production fell 4.1% QoQ from Q2, which is likely misleading.
If you look at the gold-production QoQ-change column above, component increases are much more common than decreases at 17 to 10. And the average of all these changes is a hefty production jump of 6.7%, far different from the total decline! So I suspect the reason overall production fell is because this ETFís managers are rejiggering its components and weightings to better reflect the junior-gold-mining industry.
While thatís great news for GDXJís usefulness for investors going forward, the considerable changes made between Q2 and Q3 render QoQ comparisons more challenging than usual. Keep that caveat in mind for the rest of this essay. While GDXJís internals are constantly in flux which is fine since junior gold miners are always growing and shrinking, the changes made to this ETF in Q3 were bigger than usual.
With gold plunging in Q4 due to extreme futures selling, the gold juniorsí latest gold-production costs are especially important today. The classic way of measuring gold-miner costs is cash costs. They contain all the cash expenses actually necessary to produce each ounce of gold, including all direct production costs, mine-level administration, smelting, refining, transport, regulatory, royalty, and tax expenses.
Cash costs are the acid-test measure of gold-miner survivability, showing the gold prices necessary for these miners to pay the bills and keep their doors open. In Q3í16, the top 34 GDXJ components that reported cash costs averaged $657 per ounce. That was up 3.3% QoQ from Q2ís $636, but is still very low relative to prevailing gold prices. Even gold in the high $1100s remains far from an existential threat for juniors.
Even more impressively the gold juniorsí $657 average cash costs in Q3 were right in line with the $648 reported by the major gold miners of GDX! Since the juniors operate fewer mines on average than the majors, and therefore lack the majorsí economies of scale which lower costs, itís amazing the juniors can run with the big dogs on cost control. Keeping cash costs in line in Q3 speaks highly of their operational prowess.
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 actually 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 administrative expenses necessary to oversee gold mines. All-in sustaining costs are the most-important gold-mining cost metric by far for investors, revealing minersí true operating profitability.
In Q3 these top 34 GDXJ companies which reported AISC averaged $911 per ounce. While that was up 2.7% QoQ and was considerably higher than the majorsí $855 in Q3, itís still pretty impressive for the gold juniors. As the tables above show, most of the top GDXJ components actually saw their AISCs drop substantially in Q3. That was largely a function of higher gold production, spreading fixed costs across more ounces.
These overall GDXJ all-in sustaining costs were skewed by a handful of components seeing big drops in production in Q3. With fewer ounces shouldering the burden of costs, per-ounce costs are naturally going to be higher. The more production falls quarter-on-quarter, the greater the upside impact on gold-mining costs. 16 of these top GDXJ components reported lower AISC in Q3, while only 9 reported higher ones.
Realize quarterly production declines arenít necessarily a bad thing, and usually soon reverse. The ore bodies in gold deposits certainly arenít homogeneous, with widely-varying mineralization. Gold miners often have to dig through lower-grade ore to get to higher-grade ore underneath. So overall production slides in quarters where the ore mix fed into mills, which have fixed tonnage capacities, is lower grade.
But even with Q3í16ís higher average all-in sustaining costs among GDXJís top components, the junior gold miners were very profitable. Gold averaged $1334 in Q3, which was 6.0% higher than Q2ís $1259 and the highest average price gold had seen since Q2í13. At those $911 average AISCs, that yielded big per-ounce profits of $423! That equates to profit margins of nearly a third, levels most industries would kill for.
Despite the gold juniorsí rising costs, their profits still surged 13.7% sequentially from Q2 on that mere 6.0% increase in the average gold price. The gold minersí great inherent profits leverage to gold is why these stocks are so alluring to investors. They not only soar dramatically during gold bull markets, but those huge gains are actually fundamentally justified by the underlying exploding growth in earnings.
Surging operating profits shouldíve fed rocketing operating cash flows and earnings for the junior gold miners in Q3, just as they did for the GDX majors. But depending on how they are measured, the quarter-on-quarter improvements are mixed. On average in Q3, the cash flows generated from operations by the top GDXJ components reporting them surged 15.9% QoQ! Thatís certainly impressive by any standard.
But total operating cash flows across these gold juniors were $919m in Q3 compared to $949m in Q2, a surprising 3.1% sequential drop. But again with the big weighting and composition changes in GDXJís holdings last quarter, totals simply arenít as comparable as they should be. On top of that, Q2 ended a half-year that included more foreign-company results than the off-quarter of Q3 which they donít report on.
Actual accounting profits looked far better for the juniors than operating cash flows in Q3. Total profits from these top 34 GDXJ component companies, even without some foreign ones, ran $340m in Q3. That was a whopping 119.4% higher than Q2ís $155m! Rising gold prices work wonders for the fundamentals of gold miners, resulting in exploding profitability far exceeding the underlying gains in the gold price itself.
The gold minersí strong Q3í16 operating results argue that their stocksí big massive-correction selloff in recent months is wildly overdone. The elite gold juniors of GDXJ have seen far-better earnings growth this year than almost every other sector in all the stock markets, only exceeded by the gold majors. So instead of wallowing in fear, investors and speculators should be looking to aggressively buy the juniors low.
Thatís despite gold faring much worse in Q4 than it did in Q3. Quarter-to-date, the average gold price has fallen 6.2% to $1251 per ounce. And that indeed virtually assures the junior gold minersí fundamentals wonít look as good this quarter as they did last quarter. Regardless, the juniorsí costs are so far under even current prevailing gold prices that they are still going to do fine. They will easily ride out this gold swoon.
Letís assume the gold juniorsí AISCs donít improve in Q4, staying at $911 per ounce. Itís actually highly likely they will improve substantially in Q4 as those Q3 production shortfalls at some GDXJ components reverse. So steady costs are conservative. On top of that, assume gold doesnít bounce in Q4 which is unlikely after such extreme gold-futures selling. Thus goldís current QTD average of $1251 will hold strong.
This implies the GDXJ junior gold miners will still earn an impressive $340 per ounce in the current dark Q4! While indeed down 19.7% from Q3ís levels, that still represents hefty 27% operating margins. These are very high by almost every other industryís standards. And when gold inevitably bounces after the heavy futures selling passes as always, the operating profitability of the juniors will again leverage goldís gains.
Considering the junior-gold sector as represented by GDXJ has plunged 35% at worst in recent months on a likely quarterly-profits drop around just half that, the selling is excessive. It never had anything to do with fundamentals, which remain very strong. The entire massive correction was a sentiment thing, investors and speculators succumbing to their own fear and rushing to sell low instead of acting rationally.
Gold wonít linger near these lows for long, which means neither will the junior gold stocks. Gold tends to be an anti-stock trade. Futures speculators jettisoned gold like crazy since the election because the stock markets and US dollar were both soaring on surprise euphoria after Trumpís win. But when the hard challenges of changing things crush the fantasy, stock markets will roll over again and gold will return to favor.
While investors can certainly buy GDXJ to ride the coming enormous profits growth in the junior miners as gold rebounds, Iíve long preferred handpicking individual stocks. GDXJ suffers from serious over-diversification, which really retards its ultimate potential gains. The best juniors with superior fundamentals will trounce GDXJ, which is why Iíd much rather own the best individual stocks and forgo the rest.
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The bottom line is the junior gold minersí fundamentals in recently-reported Q3í16 were very strong and bullish. Despite higher all-in sustaining costs, the higher gold prices still led to improving operating cash flows and exploding accounting profitability. This year the gold juniors have enjoyed a truly amazing fundamental transformation. And it is only just starting like goldís young bull market, which will soon return.
But unfortunately today most investors and speculators arenít paying attention to the gold juniorsí strong fundamentals. Instead they are all wrapped up in the fearful prevailing sentiment. Thatís a big mistake as always. While the gold juniorsí operating profitability will indeed decrease in Q4 if gold prices stay low, goldís bull is far from over. When it starts powering higher again on weaker stock markets, juniors will soar.
Adam Hamilton, CPA December 2, 2016 Subscribe at www.zealllc.com/subscribe.htm