Gold Miners’ Q3’18 Fundamentals | Adam Hamilton

by Adam Hamilton on Nov 16, 2018

The major gold miners’ stocks remain mired in universal bearishness, largely left for dead. They are just wrapping up their third-quarter earnings season, which proved challenging. Lower gold prices cut deeply into cash flows and profits, and production-growth struggles persisted. But these elite companies did hold the line on costs, portending soaring earnings as gold recovers. Their absurdly-cheap stock prices aren’t justified.

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 40 calendar days after quarter-ends. Canadian companies have similar requirements at 45 days. In other countries with half-year reporting, many companies still partially report quarterly.

These quarterlies offer the best fundamental data available for individual major gold miners, showing how their operations are really faring. That helps dispel the thick obscuring fogs of sentiment that billow up the rest of the time. While I always eagerly anticipate perusing these key reports, I worried what this Q3’18 earnings season would reveal. Lower gold prices, flagging production, and weak sentiment are a witches’ brew.

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 50.5x 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.

My earnings-season trepidation soared on October 25th. The gold stocks were doing fairly well then, with GDX rallying 14.4% out of mid-September’s deep forced-capitulation lows. Sentiment was slowly improving. But that day GDX plunged 4.4% out of the blue, and the flat gold price at upleg highscertainly wasn’t the driver. The most-loved major gold miner had plummeted after reporting shockingly-bad Q3 results.

Goldcorp has always been one of GDX’s top components. It reported mining just 503k ounces of gold last quarter, which plunged 11.9% sequentially quarter-on-quarter and 20.5% year-over-year! That forced its all-in sustaining costs a proportional 20.8% higher YoY to $999 per ounce. Investors panicked and fled, hammering GG stock 18.7% lower. That was the worst down day in the 24.6-year history of this company.

That left it at an extreme 16.2-year low! GG hadn’t been lower since August 2002 when gold was still in the low $300s, it was apocalyptic. That really torpedoed still-fragile sentiment in this sector, even though GG’s woes looked short-lived. It was bringing a new expansion online at one of its big mines, which was what caused the shortfall. Now in Q4’18 Goldcorp expects production to rebound to 620k ounces at $750 AISCs.

After GG’s Q3 disaster, I worried frayed investors would dump other gold stocks on any hints of less-than-optimal quarterly results. But GDX has ground sideways on balance since that GG shock, weathering this risky earnings season with sentiment so fragile. Ever since I’ve been anxious to analyze the collective Q3 results of the major gold miners as a whole, to see if GG’s travails were unique to it or more systemic.

GDX’s component list this week ran 48 “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 93.5% of its total weighting! These elite miners that reported Q3’18 results produced 296.4 metric tons of gold, which accounts for fully 33.9% of last quarter’s total global gold production. That ran 875.3t per the recently-released Q3’18 Gold Demand Trends report from the World Gold Council. I’ll discuss production more below.

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 major 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 Q3’18 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 Q3’18 production in ounces, which is mostly in pure-gold terms. That excludes byproduct metals often present in gold ore.

Those are usually 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, those GEOs are included instead. Then production’s absolute year-over-year change from Q3’17 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, revenues, 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. Was Goldcorp’s disaster systemic?

Production has always been the lifeblood of the gold-mining industry, since the gold miners can easily sell every ounce they can wrest from the bowels of the earth. While the gold price is also important, generally the more gold they mine the greater their operating cash flows and profits. That generates more capital to invest in future production, which comes from expanding existing mines and building or buying new ones.

Gold-stock investors have long prized production growth above everything else, as it is inexorably linked to company growth and thus stock-price-appreciation potential. But for some years now the major gold miners have been struggling to grow production. Large economically-viable gold deposits are getting increasingly harder to find and more expensive to exploit, with the low-hanging fruit long since picked.

More and more gold-industry experts believe peak gold is nearing, after which global mine production will start declining. For many years now new deposit discoveries and mine builds have failed to keep pace with depletion at existing mines. So production growth is slowing. According to the World Gold Council’s latest fundamental data, global mine production only edged 0.8% higher in 2017 compared to 5.3% in 2013!

GDX’s major gold miners are the biggest and best in the world, with access to many billions of dollars of capital to expand their operations. Yet many of them are still having trouble finding and adding enough new production to offset the normal declines in their aging operations. So while Goldcorp’s Q3 production plunge was extreme, it certainly wasn’t unique. Out of GDX’s top 10 miners by Q3 ounces, 9 saw YoY declines!

GG’s anomalous 20.5% was definitely the worst. But the 4 largest gold miners last quarter Newmont, Barrick, AngloGold, and Kinross suffered production drops of 2.0%, 7.6%, 14.6%, and 10.4% YoY in Q3. Excluding Goldcorp, those other 8 of the top 10 still averaged hefty 8.2% YoY declines last quarter. That’s pretty serious by any standard. Overall the top 34 GDX miners’ gold production retreated 2.9% YoY to 9.5m ozs!

So on the production front they are doing worse than this industry as a whole. That latest Q3 GDT data from the WGC reports overall global mine production actually grew 1.9% YoY last quarter. So the majors are really lagging their peers and dragging down the average. And seeing their production declines mount is even more striking in a third quarter. Q3s tend to see strong production growth heading into year-ends.

Mine managers want to maximize their annual bonuses, which are often tied to the performances of their companies’ stocks. With Q3 results released 6 to 9 weeks before year-ends, they can really help fuel big late-year stock rallies if good enough. So the managers tend to sequence their processing to ensure that higher-grade ores are fed into their mills in Q3s, yielding more ounces produced despite fixed mill throughputs.

Within individual gold deposits, ore grades vary considerably. Mine managers have to decide which parts of the deposits they are going to dig and haul in any given quarter, and when to run that ore through the mills. They seem to like to process their higher-grade ores in Q3s when bonus calculations are nearing, and their lower-grade ores in Q1s when year-ends are far away. This surprising herd behavior is well-documented.

Again per that comprehensive fundamental data from the WGC, over the last 8 years including 2018 global gold mine production has dropped an average of 9.0% QoQ from Q4s to Q1s! Every one of these transitions was negative, ranging from -6.7% to -12.0%. The mine managers collectively want to take the lower-ore-grade production hits early in years. They stockpile their better higher-grade ore for processing in Q3s.

In that same span between 2011 to 2018, global gold mine production has surged an average of 6.6% higher QoQ from Q2s to Q3s! Every single year saw positive growth between +4.4% to +9.1%. There’s no doubt the top GDX gold miners really wantedto show big Q3’18 production growth as well, to maximize Q4 stock-price gains and managers’ compensation. But ominously they still couldn’t pull it off last quarter.

Three big South African gold miners AngloGold, Gold Fields, and Sibanye Gold didn’t break out their Q2’18gold production in that prior earnings season. They instead lumped it into half-year reporting, likely to mask slowing production. But they did report it in Q3’18 in their quarterly operational updates. So if we exclude them, the rest of the GDX top 34’s gold production merely grew 1.1% QoQ in Q3 which is really slow.

If the world’s top gold miners couldn’t scrounge up enough higher-grade ore to report strong Q3s, they are really hurting on the production front! As I’ve warned for years, investors can and should avoid most of the majors because of this. Growing gold production is always challenging, but incredibly difficult off of really-high bases. The best production growth and stock-price upside comes from the smaller mid-tier miners.

Unfortunately the majors’ flagging production is a vexing problem for this entire sector because these large companies dominate GDX and the gold-stock indexes. Speculators and investors alike look to their performances to gauge how gold stocks are faring, which heavily colors their psychology and perceptions on gold miners’ potential. So the majors’ production struggles weighing down the indexes exacerbates bearishness.

Q3’s disappointment wasn’t something new either, as the top 34 GDX gold miners also reported sharp Q2’18 production declines of 7.7% YoY. The majors are starting to get desperate since they can’t bring their own new projects online fast enough to offset existing-mine depletion. So they are looking to buy other operating mines and even entire companies at high premiums to restore their flagging production growth.

We just saw a huge example late in Q3, when Barrick announced it was merging with Randgold! The world’s 2nd-largest gold miner and GDX component was effectively buying the 10th-largest gold miner and 7th-largest GDX component in an all-stock deal. The combined company would’ve been the world’s largest gold miner in Q3 at 1458k ozs. But with production waning at both ABX and GOLD, the problem remains.

While Q3’18’s underperformance by the biggest gold miners dominating GDX was striking, it is nothing new. That’s why I’ve long recommended investors avoid many of the largest gold miners. Mid-tier miners with growing production as they bring new mines online and much-smaller market caps have far-greater upside potential during gold uplegs. They are bucking the increasingly-evident peak-gold predicament.

Peak gold is likely bearish for the largest gold miners that drive GDX. Capital inflows from investors will wane along with their shrinking production. But lower gold mined supply on balance going forward is wildly bullishfor the mid-tier and junior gold miners growing their production! The resulting higher gold prices will catapult their profits and thus stock prices far higher, attracting investors fleeing the struggling majors.

The only way to reap these massive gains is directly investing in the best individual gold miners. Their fundamentals are far superior to their sector’s as a whole. While buying GDX is easy, the lion’s share of that capital is funneled into the major gold miners with slowing production. Their underperformance will dilute away any outperformance among mid-tier miners in this ETF, leading to mediocre overall gains.

With many of the major gold miners’ seeing lower or stagnant production, their mining costs should’ve risen proportionally. Gold-mining costs are largely fixed quarter after quarter, with actual mining requiring the same levels of infrastructure, equipment, and employees. So the lower production, the fewer ounces to spread mining’s big fixed costs across. The silver lining to the gold majors’ Q3 is they held the line on costs.

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 Q3’18, these top 34 GDX-component gold miners that reported cash costs averaged $631 per ounce. That was indeed up 6.8% YoY, but still radically below even gold’s $1174 mid-August low.

That was an anomaly driven by all-time-recordgold-futures short selling by speculators. The gold miners face no existential peril as long as prevailing gold prices are well above their cash costs of production. Interestingly much of that extreme gold-futures short selling has yet to be unwound, which means gold-upleg fuel still abounds. The gold stocks leverage gold’s moves since its price levels drive their profitability.

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 replenishoperations 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.

Back in late October when Goldcorp’s horrible Q3 wrecked gold-stock sentiment, I feared soaring AISCs might be the norm last quarter. Remember GG’s AISCs soared 20.8% YoY on its 20.5% production drop, perfectly inversely proportional. So it was a pleasant surprise to see these top 34 GDX gold miners even including GG fully contain their average AISCs in Q3. They only rose 1.0% YoY to $877 per ounce, a big victory!

That’s right in line with the previous four quarters’ $868, $858, $884, and $856 averaging $867. So while the gold majors have production-growth problems, they are not manifesting on the cost front. These elite companies are optimizing existing mines to lower production costs and choosing new mine builds that are cheaper to operate. That bodes well for this industry going forward, portending surging profits as gold recovers.

Gold-mining earnings are simply the difference between prevailing gold prices and all-in sustaining costs. In Q3 gold averaged $1211 per ounce, implying average profits of $334 at $877 average AISCs. That is still pretty impressive, implying solid 28% profit margins even in a weak quarter for gold prices. So GDX getting pounded to a 2.6-year low in mid-September on forced selling as stops were run wasn’t justified.

Those recent gold-stock lows were actually fundamentally absurd, resulting from irrational excessively-bearish sentiment. They had nothing to do with fundamentals. GDX was back down near its stock-panic lows from October 2008, when gold was languishing under $750. Seeing gold-stock prices revisit those levels in recent months with gold prices over 55% higher made no sense at all! Gold stocks are far too low.

That’s true even though Q3 was a tough quarter. It wasn’t just the production challenges, but that $1211 average gold price in Q3’18 was 5.3% underits Q3’17 average. Gold miners’ earnings leverage both upside and downside gold-price moves, really hurting profitability. In Q3’17 these top 34 GDX miners were earning $411 per ounce on average, so industry profits fell 18.7% YoY making for 3.6x downside leverage.

The lower prevailing gold prices along with flat-to-lower gold production certainly weakened the normal accounting metrics of major gold miners’ health. The cash flows generated from operations by these top GDX components plunged 29.0% YoY to $3155m. Revenues dropped 7.4% YoY to $9599m, mostly due to lower gold prices but also reflecting 9.2% lower byproduct silver production among these major gold miners.

And their hard GAAP earnings reported to regulators looked ugly, weighing in at a considerable $566m collective loss in Q3’18 compared to $854m of profits in Q3’17! While lower gold prices naturally lead to lower profits, that was far beyond what gold’s drop warranted. But thankfully this latest quarter’s profits were greatly skewed to the downside by a couple of huge mine-impairment charges from GDX’s biggest components.

When gold deposits look less economically viable due to weaker gold prices or tougher geology than was originally expected, miners write down their carrying values which flushes big non-cash losses through their income statements. Newmont reported a $366m impairment charge in Q3 on some of its exploration properties in North America. Barrick ran through an even-larger $431m writedown in Q3 on a mine in Peru.

Both of these big impairment charges turned operating profits at the world’s two biggest gold miners into deep losses. If they are excluded, the top 34 GDX gold miners earned $231m in Q3’18. While still down an ugly 73.0% YoY, at least the major gold miners were still earning money last quarter. So there was nothing particularly troubling on the hard-GAAP-earnings front in Q3, but it was still really weak for gold miners.

But they remain ready to expand, collectively sitting on a big $11.7b cash hoard at the end of Q3’18. That was merely down 0.4% YoY, reflecting relatively-solid operating cash flows and access to financing capital. I suspect some of this will be deployed in buying up smaller gold miners with operating mines, since it takes over a decade to bring new deposits into production. The major gold miners will fight to show future growth.

Left for dead and neglected, the gold miners’ stocks are the last cheap sector in these lofty bubble-valuedstock markets. Their fundamental upside as gold mean reverts higher on speculators’ gold-futures buying and new investment demand as stock markets roll over is enormous. This is easy to understand with a simple example. In the last four quarters including Q3’18, the top GDX gold miners’ AISCs averaged $869.

During gold’s last major upleg in essentially the first half of 2016, it powered about 30% higher driven by surging investment demand after stock markets suffered back-to-back corrections. That was even small by historical gold-bull-upleg standards. If we merely get another 30% gold advance from its recent mid-August low of $1174, we’re looking at $1525 gold. That would work wonders for gold-mining profits and stock prices.

At $1525 gold and $869 AISCs, the major gold miners would be earning $656 per ounce. That’s 96% higher than Q3’18’s $334! If gold-mining profits double, gold-stock prices will soar. Indeed during that last 30% gold bull in the first half of 2016, GDX rocketed 151% higher! So the gold-stock outlook is wildly bullishwith gold itself due to power higher as the stock markets roll over on the Fed’s record tightening.

While gold-stock sentiment remains overwhelmingly bearish, the major gold miners’ fundamentals are still solid. They are still struggling with flat-to-shrinking production, but their mining costs remain far below the prevailing gold prices. They are still generating strong operating cash flows and some profits without the inevitable non-cash writedowns sparked by weaker gold prices. OCFs and earnings will soar as gold prices recover.

So a big mean-reversion rebound higher is inevitable and imminent. While traders can play that in GDX, that is mostly a bet on the largest gold miners with slowing production. The best gains by far will be won in smaller mid-tier and junior gold miners with superior fundamentals. A carefully-handpicked portfolio of elite gold and silver miners will generate much-greater wealth creation than ETFs dominated by underperformers.

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The bottom line is the major gold miners’ fundamentals remain far stronger than implied by their left-for-dead stock prices. While they are still struggling to grow production, they are holding the line on all-in sustaining costs. That fueled solid operating cash flows in Q3 despite weaker gold prices. Both those and GAAP profits will surge dramatically in coming quarters as gold mean reverts higher on big investment buying.

Gold stocks are not only unloved and dirt-cheap today, but they are a rare sector that rallies strongly with gold as general stock markets weaken. While virtually no one was interested in these leveraged plays on gold upside in recent months, that will change fast as these lofty stock markets roll over. And the major gold miners’ just-finished Q3 earnings season proved they remain ready to fundamentally amplify gold’s gains.