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Gold Miners' Profits to Soar

Adam Hamilton
Oct 18, 2019

The gold miners are likely to report blowout profits in this spinning-up Q3'19 earnings season. Higher production, stable costs, and much-higher gold prices should combine for some super-impressive results. That's going to leave the still-undervalued gold miners much more attractive fundamentally, supporting bigger capital inflows and much-higher stock prices. Q3 should prove the gold miners' best quarter in years.

Stock prices are ultimately dependent on underlying corporate earnings. Over the long term all stock prices gravitate towards some reasonable multiple of their underlying companies' profits. Herd greed and fear can force stock prices to disconnect from fundamentals for some time, but eventually they trump sentiment. So there's nothing more important for stock-price-appreciation potential than foundational profits.

Most of the major gold miners trade in the US or Canada, and thus are required to report their results quarterly. The SEC deadline for filing 10-Q quarterly reports is 40 calendar days after quarter-ends, or November 9th for the recently-finished Q3'19. The major gold miners tend to report in the latter end of that window. The definitive list of them comes from the leading gold-stock trading vehicle and benchmark.

Of course that is the GDX VanEck Vectors Gold Miners ETF. This week its top holdings are Newmont Goldcorp, Barrick Gold, Newcrest Mining, Franco-Nevada, and Wheaton Precious Metals. Together they account for 39.7% of GDX's total weighting. NEM is releasing its Q3 results on November 5th, GOLD on November 6th, NCM likely in late October, FNV probably in early November, and WPM on November 14th.

Wheaton can get away with missing the US deadline because it is Canadian, while Newcrest is based in Australia where public companies report in half-year increments. It still publishes partial quarterly data. The lion's share of gold miners' Q3'19 results will be released in the last week of October and the first couple weeks of November. Once they're all out in a month, I'll dig into all the GDX majors' results as always.

But heading into quarterly earnings seasons, it is prudent to consider how the gold miners are likely to fare. Their stocks can see strong upside if good operational and financial performances surprise traders, or vice versa if they disappoint. This imminent Q3 earnings season is likely to prove the gold miners' best in years, which is really exciting. Generally three major components drive this industry's overall profits.

They are production, costs, and gold prices. The more gold mined, the lower its mining costs, and the higher prevailing gold prices, the greater the major gold miners' earnings. For the first time in at least several years, all these are lining up very favorably for Q3. Speculators and investors who don't closely follow this relatively-obscure contrarian sector are likely to be surprised by how good the gold miners are doing.

Gold-mining production levels are interesting. Traders don't often think about them from an industry-wide level, generally assuming that existing gold mines' outputs are largely steady states. Individual mines can see big production surges periodically on expansion projects, and all gold mines are inexorably depleting. But quarter-to-quarter, there's a perception that the mined gold supply is relatively constant. But actually it's not!

The best global fundamental data available on gold is published quarterly by the World Gold Council. The latest is current to Q2'19, as the WGC's comprehensive and must-read Gold Demand Trends reports are typically published about a month after calendar quarters end. That latest one has quarterly global mined supply running back to 2010. Crunching those numbers reveals hidden gold-supply trends few are aware of.

Since 2010, calendar Q1s, Q2s, Q3s, and Q4s have seen average quarter-on-quarterproduction changes of -7.4%, +5.3%, +5.4%, and +0.5%! Q1s tend to see a sharp QoQ drop in global gold-mining output. It is then more than made up with big growth in Q2s and Q3s. Q3's +5.4% QoQ average makes it the best quarter of the calendar year. Then in Q4s that growth largely ceases, and this whole cycle begins anew.

Why on earth does global mined supply fluctuate so wildly quarter to quarter? I've talked with gold-mining executives about this over the years, and they've offered a couple explanations. Most mining companies operate on calendar years. So Q1s start new years with new budgets to maintain and expand existing gold mines. These freshly-funded projects often require operations to be temporarily taken offline to implement.

Q1s are also good times to work on gold mines since most of them are in the northern hemisphere. Winter weather complicates mining operations in multiple ways. Examples include essential water inflows to mining sites dwindling as temperatures spend more time below freezing, snow and ice slowing down haul-truck routes out of mines, and ore processing being less efficient with big temperature and moisture fluctuations.

Mine managers also have to choose which areas of which ore bodies they want to blast apart, haul, and run through their mills in any given quarter. Mills' throughput is fixed, they can only process so many tons of ore per day. So the richer the ore being mined, the more ounces of gold produced. Lower-grade ores seem to be more often mined in Q1s, while higher-grade ores are saved for later in Q2s and especially Q3s.

I suspect compensationplays a big role in these decisions. Mine managers are partially compensated in company shares or options, which can make up the lion's share of their income when their stock prices are rising. Stock-based compensation is often figured heading into or right after year-ends. Q1s' results reported by mid-Mays are far from year-ends, so that's the time to take production hits from lower-grade ores.

But Q2s' results reported by mid-Augusts are getting closer to year-ends, so share-price appreciation is getting more important for stock-compensation calculations. And mine managers are really keen to show strong results in Q3s, which are released by mid-Novembers just 7 weeks before year-ends. So they are probably collectively making decisions to maximize ore grades mined in Q3s, to boost their stock prices.

Between Q3'10 to Q3'18, the entire world's gold-mine production has never declined sequentially from the preceding Q2s' results. Q3s' best-of-the-year 5.4% average QoQ growth came from individual Q3s that saw 8.1%, 4.5%, 5.4%, 9.0%, 8.9%, 3.6%, 3.4%, 3.8%, and 1.6% QoQ growth since 2010. So there's every reason to expect big 5%ish world-gold-mining-output growth to be revealed in the coming Q3'19 results!

Q2'19's big 4.1% QoQ gold production growth was roughly in line with Q2s' average of +5.3%. If Q3s' gold-mining output continues that trend, the gold miners' earnings are going to enjoy a major boost from it. Since mining costs are largely fixed quarter after quarter, higher output produced profitably flows directly through to miners' bottom lines. 5%ish higher gold output in Q3'19 compared to Q2'19 is a big deal.

I haven't yet done the daunting research project to try and quantify how quarterly changes in gold-mining output alone affect earnings. But after wading through countless quarterly reports over the decades, I know the impact is material if not substantial. Q3'19's imminent earnings season is likely to see the best collective gold production growth this year, and that's going to translate into higher profits for the miners.

Meanwhile the major gold miners' average reported costs are likely to remain flat in Q3. The premier measure of gold-mining costs is all-in sustaining costs, which reveal how much it costs to maintain current mining tempos indefinitely. That includes replenishing depleting deposits. Every quarter I dig deep into the GDX major gold miners' latest results, and the most-recent available are mid-August's Q2'19 ones.

In Q2 the top 34 GDX gold miners reported average AISCs of $895 per ounce. That was on the high side compared to recent years, mostly due to anomalous outliers skewing it. Since Q2'16 when I started this particular quarterly research thread, the GDX gold miners' AISCs have averaged $876. And that is from a tight range of $855 to $895. The quarterly production trends naturally play into how AISCs shake out.

Again most gold-mining costs are fixed. No matter how rich the ore being fed into mills, it generally takes the same levels of infrastructure, equipment, and employees working quarter after quarter. So the more gold produced, the more ounces to spread those big fixed costs across. So higher gold output tends to lower average AISCs. Q3s' big average production growth tends to reduce AISCs sequentially that quarter.

Thus odds are the dominant GDX-top-34 major gold miners are going to report Q3'19 average AISCs under Q2's $895. If the outlying skewing companies made progress in controlling their costs, $875ish is totally doable. That is right in line with the last 13 quarters' overall average of $876. But let's remain conservative and assume Q2'19's higher $895 AISCs hold into Q3 despite its normal production surge.

So on the production front Q3'19 is likely to see 5%ish average production growth. And conservatively on the cost front the major gold miners of GDX should report average AISCs below $895 per ounce. That leaves the most important factor which is going to supercharge Q3 results, much-higherprevailing gold prices! They would greatly goose gold-mining profits even if production was falling and costs were rising.

Gold stocks are effectively just leveraged plays on gold, since that metal overwhelmingly drives their earnings and thus stock-price-appreciation potential. Gold was relatively weak for most of Q2'19, just averaging $1309. Back in early May heading into the middle of Q2, gold slumped as low as $1271. It was largely languishing and neither gold-futures speculators nor investors wanted anything to do with it.

But in late June at the very end of Q2, gold blasted higher after top Fed officials' collective outlook for the future rate trajectory shifted from hiking to cutting. Gold shot higher on that, surging to its first new bull-market high in 2.9 years the next day! That long-awaited decisive bull-market breakout rekindled traders' flagging interest in gold. So capital flooded back in through much of Q3, driving gold sharply higher.

By the time the dust settled on last quarter, gold's average price had rocketed an enormous 12.6% higher quarter-on-quarter to $1474! That massive sequential gold-price surge is going to work wonders for the major gold miners' profits in their imminent Q3 earnings season. Simplified to an industry-wide overview, the gold miners' earnings-growth potential is easy to understand. It is still going to surprise unaware traders.

Again in Q2'19 the top 34 GDX gold miners averaged $895 AISCs while gold averaged $1309 per ounce. That yielded average industry profits of $414 per ounce, which were already hefty profit margins. With that conservative assumption Q2's higher AISCs remain flat in Q3, gold-mining earnings are ready to explode higher. Q3's far-higher $1474 average gold price less $895 AISCs yields fat profits of $579 per ounce!

Thus before even accounting for Q3's usual production surge, the major gold miners' profits are likely to skyrocket 39.9% higher quarter-on-quarter in Q3'19! That is stupendous earnings growth for any sector, and will absolutely catch fundamentally-oriented institutional investors' attention. 40% sequential profits growth in a world where the big US stocks of the S&P 500 are likely to see shrinking earnings is incredible.

Still ignoring higher Q3 production, the GDX major gold miners' earnings up 39.9% QoQ would leverage gold's 12.6% QoQ surge by 3.2x. This awesome profits leverage to gold is why the major gold miners' stocks normally amplify gold's upside by 2x to 3x. During Q3 gold stocks started to reflect these wildly-better fundamentals, but all that progress has been erased by the currently-underway gold-stock correction.

This GDX chart shows gold stocks' progress throughout Q3'19. They surged sharply higher during the first 2/3rds or so of Q3, but then retreated to give up most of that ground in the final third. So the big feast of massive earnings growth coming isn't yet reflected in prevailing gold-stock price levels! They are now trading as if they might see minor profits growth, nothing close to that probable huge 40%-or-so range.

From the end of Q2 to gold's dazzling early-September peak of $1554, it blasted 10.2% higher. The gold stocks naturally rallied in that span, with GDX powering 21.1% higher. That made for relatively-minor 2.1x upside leverage. It takes some time for major gold-stock uplegs to gather steam, to convince their ever-skeptical traders that gold's advance is sustainable. So 3x+ leverage tends to come later in uplegs.

But as I warned during that early-September exuberance, selling was coming. Gold itself faced a huge gold-futures-selling overhang, with speculators' extreme excessively-bullish gold-futures positioning needing to be unwound and normalized. And gold stocks were very overbought after surging strongly since late May. All the indicators pointed to an imminent correction, and it indeed started to materialize.

From their September 4th peaks, gold and GDX dropped 5.2% and 13.7% into the end of Q3 just over several weeks later. That made for 2.6x downside leverage for gold stocks, again totally normal within that 2x-to-3x range. Such a roller-coaster of a quarter still left gold 4.4% higher from the end of Q2 to the end of Q3. But GDX's Q3 performance cratered to a pathetic +4.5%, merely keeping pace with gold's rally!

Gold-mining stocks are much riskier than gold, facing all kinds of operational, geological, geopolitical, and other risks gold doesn't. So gold stocks are only worth owning if they outperform gold enough to justify bearing their big additional risks. As of the end of Q3'19, the gold-stock prices weren't high enough to reflect their massive 40% QoQ earnings surge these much-higher prevailing gold prices probably drove.

Thus the gold stocks remain very undervalued relative to these new higher gold prices, with major upside likely after Q3's great earnings results are digested. It's probably too early to deploy capital aggressively, as gold and the gold stocks remain in correction mode. Once the necessary gold-futures selling and the resulting gold investment selling run their courses normalizing positioning, a big new upleg should start marching.

Regardless of whether that coming correction bottoming happens during the gold miners' imminent Q3 earnings season or tarries a bit longer, the gold stocks are going to look much better fundamentally after their Q3 results. That's going to attract a lot more capital going forward, giving the next gold-stock upleg even better upside potential than the last one. And that was no slouch, GDX soared 76.2% higher in 11.8 months!

So speculators and investors need to carefully watch this upcoming gold-miner earnings season, which is almost certain to prove the best in years. Do your homework now, and be ready to redeploy aggressively when this necessary and healthy gold correction passes. The fundamentally-superior gold and silver miners, especially in the mid-tier realm, have far more upside to come as this secular gold bull resumes.

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The bottom line is gold miners' earnings are likely to soar in their imminent Q3'19 earnings season. Q3s traditionally see big sequential production surges, driving better profits. Mining costs are likely to contract on that, or remain flat at worst. This combined with much-higher prevailing gold prices after gold's bull-breakout surge will supercharge gold-mining profits growth. That will greatly improve gold stocks' image.

Speculators and investors alike will take notice of this sector's best earnings reported in years. They will be much more willing to deploy capital in this small contrarian sector as this gold bull's future uplegs march higher. Far-better gold-mining fundamentals will justify far-higher gold-stock prices in the coming years. Higher prevailing gold prices work wonders for the gold miners, as their Q3 earnings will prove yet again.


Oct 18, 2019
Adam Hamilton, CPA

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