Gold Juniors’ Strong Financials

Adam Hamilton     August 21, 2015     2762 Words


The smaller gold miners and explorers have suffered catastrophic stock-price losses in recent years.  These extreme declines have led investors and speculators to assume that much of this sector won’t survive lower prevailing gold prices.  But nothing could be farther from the truth.  The hated and left-for-dead junior-gold sector is not only very strong financially today, but could still thrive at much lower gold prices.


With many hundreds of junior gold stocks trading around the world, this sector isn’t easy to measure.  They range from smaller producers with fantastic operating mines, to explorers doggedly advancing their projects in these dark times, to countless garbage shell companies that will never do anything beyond fleecing the unwary.  The proliferation of junior golds is incredible, making it difficult to wade through the morass.


For many years contrarian analysts including me struggled with attempts to track the performance of junior golds as a sector.  Many proprietary indexes were constructed, but they never caught on.  Finally in November 2009, a major ETF player solved this problem.  That’s when Van Eck Global launched the Junior Gold Miners ETF, which trades as GDXJ.  It has become the metric of choice for measuring this sector.


And per GDXJ, the carnage in junior golds has been astounding.  It peaked back in April 2011 way up near $152 on a split-adjusted basis.  But soon gold crested so traders started fleeing its miners and explorers.  GDXJ’s bottom fell out.  Things got so bad that GDXJ’s custodians felt compelled to execute a 1-for-4 reverse split in July 2013.  But with gold remaining weak since, the heavy junior-gold selling continued.


By earlier this month after that extreme gold shorting attack spawned a gold-stock panic, GDXJ plunged to an all-time split-adjusted low around $18.  Its total loss over 4.3 years was a devastating 87.8%!  There is little doubt junior golds were the worst-performing sector in all the stock markets, a terrible distinction.  Such mind-boggling wealth destruction led most investors and speculators to exit this cursed sector forever.


Like everyone who sells low after a long price decline, these traders attempted to rationalize their fleeing decision as prudent and wise.  There was a growing consensus that most of the smaller gold miners and explorers were doomed.  Gold prices were too low to fuel profitable operations for the miners, and the explorers didn’t have a prayer of raising essential capital in these equity markets.  The juniors had no hope.


But as always when literally everyone is convinced any sector will move in one direction forever, this sentiment was dead wrong.  While it’s been an exceedingly-challenging couple of years for the junior gold companies, they’ve ridden out this hellstorm surprisingly well.  You certainly wouldn’t know it from their epically-low stock prices, but their operational performance and financials today are actually quite strong!


This heretical idea is so counter to popular opinion that few are even willing to consider it.  Anyone that is foolish enough to even assert that junior golds have strong financials today will be laughed off of the podium.  But that’s exactly what the cold, hard data from the junior golds’ brand-new Q2 financial results proves.  And the definitive list of elite junior gold stocks is found in the holdings of that GDXJ junior-gold ETF.


This week GDXJ’s custodians held 61 “gold stocks” in this ETF’s portfolio.  The quotation marks are because this “Junior Gold Miners ETF” oddly includes silver miners as well.  It also has exploration-stage companies, royalty companies, and streaming companies, all of which aren’t technically gold miners.  But these other types of ventures are certainly within the wheelhouses of junior-gold investors and speculators.


Reading through quarterly reports is tedious and time-consuming, and I didn’t have enough time or patience this week to read through all 61 of GDXJ’s component companies’ results.  So I chose the 34 largest GDXJ components, the stocks with the top weightings, to analyze their Q2 results.  Why 34?  That’s how many fit in these tables below.  Together they account for over 5/6ths of the entire weight of GDXJ.


This deep-research project actually started last week, when I did the same for the major gold miners of the GDX Gold Miners ETF.  Also strangely, some of GDX’s components are also included in GDXJ.  If I was constructing these underlying indexes, I certainly wouldn’t allow overlap.  My thesis last week was that the popular notion that the gold-mining industry’s costs today are around $1200 per ounce is totally false.


The bears spent last month using this fallacy to argue that selling gold stocks at extreme lows was totally rational, since these companies couldn’t survive for long under $1200.  But the actual Q2 results from the top 34 GDX components proved that this industry’s average all-in sustaining costs were just $895 per ounce.  As long as gold is above those far-lower levels, their operations continue to remain profitable.


Equally important, the major gold miners of GDX had an average cash cost in Q2 of just $635 per ounce!  That means they could survive for a long time even if gold was to miraculously plunge far under $800 as some of the legions of bears still forecast.  After that popular essay showing today’s gold prices and far lower are no threat to gold miners, I got a deluge of e-mails wondering about the juniors’ precarious position.


Theoretically the larger gold miners should be much stronger than the smaller ones.  The big guys have multiple mines, with many having multiple orebodies with different cost structures from which to mine gold.  Their diversified mine portfolios give them far more flexibility in weathering extreme gold-price anomalies than single-mine operations, which describes most junior miners.  They should’ve looked worse.


So I was shocked this week to find that the junior gold miners were actually looking stronger than the majors in some ways!  Their collective costs of mining gold are slightly lower than the majors’, in both cash and all-in-sustaining terms.  Of the top 34 companies in GDXJ, the gold miners had average cash and all-in sustaining costs of $613 and $858 in the second quarter of 2015!  They are actually thriving today.


These tables summarize the results from those 34 top-GDXJ-component quarterly reports.  Not all data was provided by every company, as they trade around the world on different exchanges with different financial-reporting standards.  Whenever I couldn’t find information for a company, I left that field blank.  The explorers are evident as the companies with zero production in Q2, shown in the final column on the right.


Each company’s cash cost per ounce, all-in sustaining cost per ounce, and AISC guidance for all of 2015 is noted.  I also looked at balance-sheet strength in terms of cash on hand, cash’s percentage of the current market capitalization, cash provided by operations, and debt service.  While the latter couldn’t fit on these tables, none of these companies had any problems easily making debt payments with operating cash flows.



The top junior-gold companies’ Q2 results revealed a vastly-healthier industry than anyone believes with their stocks in the dumps.  Every company with the exception of Harmony Gold, a high-cost South African deep miner, has cash and all-in sustaining costs well below current gold prices.  Again the averages were $613 and $858 in Q2, slightly better than the GDX elites with their $635 and $895 averages.


This means the top junior gold miners could survive indefinitely at $900 gold, and even weather an anomaly under $650 for many quarters.  The latter cash-cost number includes all the costs of mining gold except corporate-level administrative expenses.  It is the acid test for survival, and $650 gold is apocalyptic.  All-in sustaining costs include everything necessary to maintain current production levels, including exploration.


As long as all-in sustaining costs remain below gold prices, gold miners can endure forever with little problem.  So obviously the prevailing $1100 levels seen recently pose zero threat to these junior gold miners.  Thus the relentless selling of the past couple years, and last month’s full-on panic exodus, was totally irrational.  The investors and speculators who succumbed to fear to sell low are fools, as they will soon learn.


Last week when I dug into the Q2 cost structures of the major gold miners of GDX, their price-to-earnings ratios largely didn’t reflect their operating profitability.  This is because accounting rules forced most to mark down their mines and projects due to the low prevailing gold prices.  These non-recurring and non-cash charges usually dwarfed normal profitability, leading many of the majors to report trailing-twelve-month losses.


But as soon as these extreme write-offs roll off the books once they are over four quarters in the past, the major gold miners’ accounting earnings will suddenly explode.  These companies will look dirt-cheap on a traditional fundamental basis, with trailing P/Es in the single digits in many cases!  Provocatively, the accounting-earnings situation in the elite junior golds is already much better than that in the majors.


6 of GDXJ’s top 34 components already have P/E ratios today under 14x earnings, compared to just 5 in GDX.  But of those 5 in GDX, 4 are also included in GDXJ and their gold production levels definitely classify them as junior miners.  So as a whole, the smaller gold miners are outperforming the major ones in P/E-ratio terms before those one-off write-downs fade into history leading to accounting earnings exploding higher.


The junior gold miners’ low operating costs today are confirmed by their large operating cash flows.  As these tables reveal, in Q2 2015 when gold averaged just $1193 most of these small miners earned tens of millions of dollars on their operations.  Several earned more than $100m!  These are big numbers relative to their small market capitalizations.  As long as any business is cash-flow-positive, it can never fail.


By definition, the junior explorers have no mines so they can’t generate cash from operations.  They instead burn cash every quarter as they work to advance their projects, and this usually comes from stock offerings.  All the elite junior explorers in GDXJ’s top holdings had really modest cash burn rates in Q2 compared to their cash balances.  They could continue their work for years even without issuing more stock.


And the cash in the bank these elite juniors held was super-impressive on multiple fronts.  Almost all of them are cash-rich, holding large cash balances relative to their stocks’ market capitalizations.  The “%MC” column above shows each junior’s cash as a percentage of its market cap.  On average these junior precious-metals companies hold cash equal to a quarter of their value.  They are very well-financed today.


Just like for individuals, cash balances for businesses provide rainy-day funds.  They guarantee that operations can continue regardless of prevailing gold prices or anomalous lows.  And when you combine large cash balances with high ongoing operating cash flows from mining gold at costs far below current prices, many of the junior golds look bulletproof.  They are strong enough to survive a gold apocalypse.


And the odds of that are virtually zero despite the groupthink bearish sentiment dominating traders’ gold-stock outlook today.  Just a few weeks ago, gold was plunging so analysts came out of the woodwork to forecast major new gold lows imminently.  Even so-called gold bulls threw up their hands in capitulation, calling for deep sub-$1000 lows before anything good could happen.  But their herd mentality was dead wrong.


As I wrote the very week gold fell to $1084, gold’s recent lows were totally artificial and unsustainable.  They were driven by epic record shorting by American gold-futures speculators.  And lows caused by extreme futures shorting are never righteous or sustainable because all those futures borrowed to be sold short must soon be bought back to be repaid.  Excessive gold-futures shorts are guaranteed near-future buying.


And of course this hardcore contrarian thesis that was universally ridiculed just a few weeks ago is now coming to pass.  This week gold has climbed dramatically on short covering, and that is just the tip of the iceberg relative to the extreme levels of speculator shorts.  Recent history has proven it takes several months to unwind excessive short positions, and the resulting gold-futures buying catapults this metal higher.


Gold’s nascent recovery and overdue mean reversion higher is super-bullish for the junior-gold realm!  A few weeks ago, the battered junior-gold stocks were priced as if gold was going to imminently plunge under $700.  Investors and speculators alike were doubting this sector’s ability to continue operating as a going concern.  Yet gold not only bottomed near $1084, but it has powered well into the mid-$1100s since.


With gold-mining costs being essentially fixed, higher gold prices translate directly into higher profits for mining it.  So the profitability of the entire junior-gold sector is going to soar as gold recovers.  And gold-mining profits leverage this relationship, it certainly isn’t linear.  At average all-in sustaining costs of $858 per ounce, the junior golds were earning operating profits of $226 per ounce at those $1084 gold lows.


But a mere 6.1% gold rally to $1150 boosts the elite junior golds’ operating profits to $292, a huge 29% jump!  And the average gold-futures-short-covering-driven gold rally in recent years was 16.2% in 10 weeks.  Such a merely-average short-covering rally today would blast gold back up to $1260 within a couple months on the outside.  That would lead to junior-gold profits of $401 per ounce, a staggering 78% increase!


This incredible profits leverage to gold is what makes all gold miners’ stocks, both majors and juniors, so incredibly bullish today.  The gold stocks were recently beaten down to fundamentally-absurd levels not because their operating profits collapsed, but because traders were scared.  As that excessive fear soon passes as always, aided by gold’s recovery, they are going to rush back into this radically-undervalued sector.


This has already started in the best of the junior golds, with many of their stocks surging 5% to 10% a day this week!  And since higher gold prices will lead to exploding operating profits, operating cash flows, and accounting profits, the gold-stock mean-reversion rally has just begun.  Higher profits relative to such low stock prices will lead to collapsing trailing-twelve-month P/E ratios, attracting value-investing funds.


Despite the incredible carnage it has suffered in recent years, the junior-gold-mining industry remains strong and healthy on a fundamental basis.  Its operating costs are very low, leading to robust operating cash flows.  And these are rapidly growing already-massive-relative-to-market-caps cash hoards, which is further fortifying the balance sheets of the elite juniors.  Investors and speculators will soon realize this.


They can certainly play this emerging major junior-gold upleg in GDXJ.  It is a fine ETF, and a great way to track this sector’s fortunes.  But like any large overly-diversified portfolio of 60+ holdings, GDXJ’s performance will greatly lag the best of its junior-gold components.  Vastly-superior returns will be won by those investors and speculators prudently handpicking the fundamental best of the elite junior golds.


We’ve long done that at Zeal.  Since late July when everyone else was panicking and explaining how wise it is to sell into extreme lows, we’ve been aggressively buying.  We’ve added 20 amazing new gold-stock and silver-stock trades in our acclaimed weekly and monthly newsletters since then, and their gains are already approaching +50% at best!  Fighting the herd to buy extreme fear always leads to huge profits.


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The bottom line is the elite companies in the junior-gold-mining industry remain very strong fundamentally despite all the naysaying.  Their collective costs for mining gold remain radically below prevailing gold levels, even at the recent anomalous lows.  This is fueling strong operating-cash-flow generation that is overflowing coffers with large hoards of cash.  Fear, not fundamentals, drove their recent extreme stock lows.


Investors and speculators are already starting to realize their great folly in getting caught up in popular fear to sell into a gold-stock panic.  The junior-gold stock prices were battered so low that they are going to soar by multiples as capital returns and gold recovers.  There is no other sector in all the world’s stock markets with anywhere near the incredible appreciation potential of the left-for-dead junior gold miners.


Adam Hamilton, CPA     August 21, 2015     Subscribe