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Gold Miners' Q1'18 Fundamentals

Adam Hamilton
May 18, 2018

The major gold miners' stocks are still largely grinding sideways, mired in a bearish sentiment wasteland. Traders tend to assume low stock prices must be righteous, reflecting weak fundamentals rather than poor psychology. But once a quarter earnings seasons' bright fundamental sunlight parts the obscuring fogs of popular sentiment. The gold miners' just-reported Q1'18 results prove they remain deeply 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 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 25.7x 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 92.1% of its total weighting! These elite miners dominate world gold mine production, which ran 770.0 metric tons in Q1'18 according to the World Gold Council's recently-released Q1 Gold Demand Trends report. The top 34 GDX gold miners reported collectively mining 286.5t of gold last quarter, nearly 3/8ths of the world's total!

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 Q1'18 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 Q1'18 production in ounces, which is mostly in pure-gold terms. That excludes byproduct metals often present in gold ore.

These are mostly 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, these GEOs are included instead. Then production's absolute year-over-year change from Q1'17 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. And that was really well in Q1'18!

As I waded through all these gold miners' new 10-Qs or their foreign equivalents this week, the biggest surprise was production. The whole business of gold mining is digging up and selling gold, so naturally production is the mothers' milk of this industry. Companies are always striving to grow their production, which boosts their cash generation and thus expansion opportunities available by finding or buying other mines.

These elite gold miners certainly had every incentive to boost their production in Q1, since its average gold price surged 8.9% YoY to $1329. Investors are always looking for rising production too, seeing it as signs of good management and strong fundamental health. Since gold stocks suffering flagging production are often punished with selling, the major gold miners really hate reporting it. Yet Q1'18 was stuffed with declines!

This wasn't readily apparent to casual observers, as the major gold miners carefully tailor their quarterly-results press releases to accentuate the positive and intentionally mask the negative. Yet if you look at the YoY changes in gold production above, fully 21 of the 33 top GDX companies reporting it suffered steep average declines of 9.6%! This lower production was so universal and widespread it looks to be systemic.

Overall these top 34 GDX companies mined 9.2m ounces of gold in Q1'18, which was down a sharp 4.6% YoY. This was actually contrary to the industry trend too. The World Gold Council's new read on Q1's fundamentals showed global gold mine production actually rising 1.4% YoY! Yet the top 10 GDX stocks commanding 60.3% of this ETF's total weighting all saw gold declines averaging a major 7.4% YoY.

Most of these top gold miners had explanations, which were often excluded from press releases. I found them deep in quarterly regulatory filings most investors will never bother looking into. Mine sequencing leading to lower ore grades, individual-mine technical challenges, and slowing production at older mines were mostly to blame. This wasn't a one-off dip though, as Q4'17's GDX-top-34 production also fell 2.0% YoY.

Investors choosing to buy GDX instead of individual gold stocks with superior fundamentals must realize the lion's share of their investments are flowing into giant gold miners with slowing production. As long as this proves true, their stocks have far-less appreciation potential than their smaller peers still able to grow production. What the top major gold miners are experiencing is increasingly validating peak-gold theses.

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 up to 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 greatly on the smaller junior gold miners to explore and replenish the gold-production pipeline. But juniors have been devastatedsince 2013, starved of capital. Not only were 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 good for those individual 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 goldhas been reached, that world 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 that can't grow production. Stock picking is more important than ever in this ETF world!

With major gold miners' production sharply lower, 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.

But interestingly this often-ironclad inverse relationship between gold production and per-ounce costs did not really play out in Q1'18. Costs rose, but nowhere near as much as the lower gold production implied they would. The major gold miners are getting more efficient. They could've also chosen to sequence lower-grade ore into their mills because higher prevailing gold prices would offset some of the production declines.

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 Q1'18, these top 34 GDX-component gold miners that reported cash costs averaged $667 per ounce. They indeed surged a sharp 7.1% YoY, the result of fixed costs spread across lower production.

These industry-wide cash costs are the gold-price pain point where miners' viability and survivability is in jeopardy. Seeing gold anywhere near those levels again is exceedingly unlikely. The last time gold hit $667 was 10.7 years agoin August 2007, before trillions of dollars of central-bank money printing after 2008's stock panic. Provocatively the HUI gold-stock index was near 320 then, 80% higher than today's levels!

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' production down 4.6% YoY in Q1, I would've bet their AISCs would've risen a proportional 4% to 5%. Yet their cost control was outstanding, as these elite gold miners reported average AISCs up just 0.7% YoY to $884 per ounce! That's roughly in line with the quarterly trend from 2017 seeing $878, $867, $868, and $858 averages running from Q1 to Q4. Costs are really being contained.

The major gold miners have to manage costs exceptionally well to maintain AISCs while production is also slowing. This argues against the popular complaint that gold miners' managements are doing poor jobs. Because gold-stock prices are so darned low, traders again assume the miners must be plagued with serious fundamental problems. But it's relentlessly-bearish herd sentiment suppressing gold-stock prices.

Flat AISCs combined with sharply-higher gold prices led to exploding operating profitability among the major gold miners last quarter! That certainly isn't being reflected in their stock prices. In Q1'17, gold averaged just $1220 against $878 average AISCs. That yielded per-ounce profits of $342. But this past year saw gold surge 8.9% to that $1329 quarterly average in Q1'18 while AISCs only climbed 0.7% to $884.

That drove fat operating margins of $445 per ounce, exploding 30.2% higher YoY! That works out to excellent 3.4x upside profits leverage to gold! In any other stock-market sector such massive earnings growth would be crowed about from the rooftops and capital would flood in. But that wasn't enough to blow away the darkening bearish pall over gold stocks. GDX's average share price still fell 3.0% YoY in Q1'18!

Gold-stock profits as measured by the difference between average gold prices and average AISCs even surged 6.3% quarter-on-quarter from Q4'17. There is a vast fundamental disconnect between the left-for-dead gold-stock prices and gold miners' strong operational performances. This bearish-sentiment-driven anomaly is very extreme and won't last forever. Investors will rush back in when they discover the value.

The major gold miners' fundamental health is reflected in their operating-cash-flow generation. These top 34 GDX gold miners reporting OCFs for last quarter collectively produced $3355m. That's up 3.9% YoY despite their 4.6% lower gold production, mostly due to that sizable 8.9% average-gold-price rally. Most of these elite gold miners saw big annual growth in cash generated from operations, a very-bullish sign.

As long as OCFs remain massively positive, the gold mines are generating much more cash than they cost to run. That gives the gold miners the capital necessary to expand existing operations and buy new deposits and mines. Given how ridiculously low gold-stock prices are today, you'd think the gold miners are hemorrhaging cash like crazy. But the opposite is true, showing how silly this bearish herd sentiment is.

These top GDX gold miners' actual GAAP profits didn't look as good, plunging 48.5% YoY to $855m in Q1. While that was a huge improvement over Q4'17's $266m loss, it still seems incongruent with those flat all-in sustaining costs and growing operating cash flows. Of the 25 of these top GDX components reporting earnings in Q1, just 3 had losses. The only big ones came from Royal Gold and Yamana Gold.

Royal Gold's $154m loss was the result of a gigantic $239m impairment charge in its interests in gold royalties. That came from Barrick Gold's big Pascua-Lama project, which straddles the border between Chile and Argentina. In Q1 Barrick decided the current economic and geopolitical environment made the Chilean side of this project not worthy of further investment. Chile's government is harassing Barrick on it.

Yamana Gold's $161m loss was largely from a $103m impairment of a majority investment it made in a smaller gold company. When a third company agreed to acquire all the shares of that smaller miner in Q1, Yamana had to write off its loss. These two impairments alone battered overall GDX GAAP profits $342m lower! Without them, the top 34 GDX gold miners' earnings would've slid a much-smaller 27.9% YoY.

It doesn't take many of these non-cash charges to greatly alter the collective GAAP earnings of the elite gold miners. And there's a third huge one to consider. Back in Q1'17, Barrick Gold recorded a colossal $1125m non-cash gainreversing previous impairment charges on a gold project after Goldcorp agreed to buy a quarter of it. That really inflated overall GDX GAAP profits in the comparable quarter a year ago.

Just excluding that huge Q1'17 impairment reversal and that pair of Q1'18 impairment charges radically changes the profits picture. Again those were non-cash and had nothing to do with operations. That yields Q1'18 GAAP profits of $1197m for these top 34 GDX gold miners, a staggering $123% higherthan Q1'17's if its Barrick impairment-reversal gain hadn't happened! The major gold miners are faring really well.

These surging accounting earnings are evident in the classic trailing-twelve-month price-to-earnings ratios of these top gold miners as well. They aren't included in these tables, but averaged 37.3x in Q1'18 for the 24 of these companies that had net earnings over the past year. While that's not an accurate reflection of true valuations due to non-cash things flushed through income statements, it was still 28% lower.

On the sales front these top 34 GDX gold miners' revenues climbed 1.5% YoY to $10.6b in Q1'18. That reflects the combination of higher gold selling prices with lower gold production. Actual sales growth was probably better, as 26 top-34 GDX companies reported sales in Q1'18 compared to 28 in Q1'17. GDX saw three new companies climb into the ranks of its top 34 over this past year, highlighted in light blue above.

Two of these are the great low-cost Australian gold miners Regis Resources and St Barbara Limited. They report in half-year increments, and gave no revenues data for Q1 which was an interim quarter for both. The companies they knocked out of the top 34 had reported sales a year earlier. So the sales growth in the elite major gold miners was really good considering their sharply-lower gold production.

Finally these top 34 GDX gold miners' cash on their balance sheets fell 4.2% YoY to $12.7b. That's a big number for this small contrarian sector, meaning these companies have lots of capital firepower available to expand existing operations or buy gold mines from other companies. The more cash on hand the gold miners have, the more flexibility and resilience they have to grow their businesses and weather challenges.

So overall the major gold miners' fundamentals looked really strong in Q1'18, a stark contrast to the miserable sentiment plaguing this sector. Gold stocks' vexing consolidation since early 2017 isn't the result of operational struggles, but purely bearish psychology. That will soon shift as stock markets inevitably roll over and gold surges, making the beaten-down gold stocks a coiled spring overdue to soar dramatically.

While investors and speculators alike can certainly play gold stocks' coming powerful uplegs with the major ETFs like GDX, the best gains by far will be won in individual gold stocks with superior fundamentals. Their upside will far exceed the ETFs, which are burdened by over-diversification and underperforming stocks. A carefully-handpicked portfolio of elite gold and silver miners will generate much-greater wealth creation.

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The bottom line is the major gold miners' fundamentals are really strong based on their recently-reported Q1'18 results. While production declined fairly sharply, the miners still held the line on all-in sustaining costs. That fueled fat operating profits and strong cash flows. And many of the elite gold miners have forecast improving production throughout 2018 on higher-grade ores, which will push profits even higher.

Yet gold stocks are priced today as if gold was half or less of current levels, which is truly fundamentally-absurd! They are the last super-undervalued sector in these euphoric, overvalued stock markets. When gold investment demand resumes on weakening stock markets and pushes gold higher, capital will flood back into the forgotten gold miners. That buying will catapult them back to far-higher fundamentally-righteous prices.


May 18, 2018
Adam Hamilton, CPA

Thoughts, comments, or flames? Fire away at zelotes@zealllc.com. Due to my staggering and perpetually increasing e-mail load, I regret that I am not able to respond to comments personally. I will read all messages though and really appreciate your feedback!

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