Do the fundamentals remain strong?
by Adam Hamilton of Zeal LLC
The mid-tier and junior gold-miners’ stocks in their sector’s sweet spot for upside potential have been clubbed like baby seals since mid-April. Sucked into the parallel serious stock-market selloff, that’s left these smaller gold stocks deeply out of favor. Yet their fundamentals remain strong as revealed in the just-finished Q1’22 earnings season. That recent brutal mid-tier-and-junior-gold-stock plunge wasn’t righteous.
Gold-stock tiers are defined by their production rates. Small juniors mine less than 300k ounces of gold annually, medium mid-tiers have outputs running from 300k to 1,000k, large majors yield over 1,000k, and huge super-majors operate at vast scales exceeding 2,000k. The mid-tiers offer a unique mix of sizable diversified production, good output-growth potential, and smaller market capitalizations ideal for outsized gains.
Mid-tiers are much-less-risky than juniors, and amplify gold’s uplegs much more than majors. These mid-tiers are nicely tracked by the GDXJ VanEck Junior Gold Miners ETF. Birthed in November 2009, it now commands $3.8b of net assets making it the second-largest sector ETF after its big-brother GDX. While GDXJ is way-superior on multiple fronts, despite its name it is overwhelmingly comprised of mid-tier gold miners.
They are universally-hated now, after GDXJ was eviscerated in a merciless 30.0% plunge in less than a month into mid-May! Speculators and investors alike have forgotten that mid-tier gold stocks were having a good 2022 before that, rallying 21.7% year-to-date by mid-April. They were nowhere near overbought then, and shouldn’t have cratered. But they were sucked into a wider market maelstrom of serious selling.
During that same span the flagship US S&P 500 stock index dropped an ugly 10.5%. The resulting big fear spike, confirmed by its VIX gauge blasting 40.4% higher, infected everything else. The safe-haven exodus from stocks into cash catapulted the US Dollar Index a monster 4.5% higher! That unleashed big leveraged gold-futures selling, hammering gold 7.6% lower which the gold stocks amplified to serious losses.
But that heavy sector selling had nothing to do with fundamentals, it was collateral damage from soaring bearish psychology. Like a match being struck, after flaring brightly extreme sentiment never lasts long. The battered mid-tier and junior gold stocks are destined to recover fast as gold resumes powering higher. Its own fundamental outlook remains super-bullish on raging inflation unleashed by extreme money printing.
Right after 24 quarterly earnings seasons in a row now, I’ve painstakingly analyzed the latest operational and financial results reported by the top-25 GDXJ gold miners. This week they collectively accounted for 62.8% of this ETF’s weighting. With a whopping 100 component stocks, GDXJ’s capital is spread across most of the better mid-tier-and-junior-gold-mining universe! Its larger holdings show how mid-tiers are faring.
This table summarizes the operational and financial highlights from the GDXJ top 25 in Q1’22. These gold miners’ stock symbols aren’t all US listings, and are preceded by their rankings changes within GDXJ over this past year. The shuffling in their ETF weightings reflects shifting market caps, which reveal both outperformers and underperformers since Q1’21. Those symbols are followed by their current GDXJ weightings.
Next comes these gold miners’ Q1’22 production in ounces, along with their year-over-year changes from the comparable Q1’21. Output is the lifeblood of this industry, with investors generally prizing production growth above everything else. After are the costs of wresting that gold from the bowels of the earth in per-ounce terms, both cash costs and all-in sustaining costs. The latter help illuminate miners’ profitability.
That’s followed by a bunch of hard accounting data reported to securities regulators, quarterly revenues, earnings, operating cash flows, and resulting cash treasuries. Blank data fields mean companies hadn’t reported that particular data as of the middle of this week. The annual changes aren’t included if they would be misleading, like comparing negative numbers or data shifting from positive to negative or vice versa.
The elite mid-tier and junior gold miners filling GDXJ’s upper ranks reported good results last quarter. Many suffered weaker production, which was largely the result of the COVID-19-omicron wave forcing lots of mine employees to stay home early-on. But these smaller gold miners still managed to mostly hold the line on costs, which combined with better gold prices fueled very-profitable fundamentally-strong operations.
Like most exchange-traded funds, GDXJ is essentially market-capitalization-weighted. That’s the most-logical way to construct ETFs, reflecting relative capital amounts traders have deployed in component stocks. But shifting market caps continually alter ETF-component weightings and rankings, and there was a lot of churn in GDXJ’s top-25 holdings over this past year. Chief among that was an excellent pruning.
For years one of this “Junior Gold Miners” ETF’s top components had been South-African super-major Gold Fields. Last quarter it produced an enormous 580k ounces of gold! There was never justification to include a gigantic gold miner like that in GDXJ, and I railed against that for years in these quarterly-results analyses. GDXJ’s managers eventually saw the light, booting GFI in Q2’21 leaving it exclusively in GDX.
Many countries including South Africa only require half-year reporting from publicly-traded companies, so GFI doesn’t release quarterly financial data. But its vast gold output rightfully being removed from this ETF over this past year greatly distorts production comparisons. The GDXJ top 25’s total gold output cratered 20.9% year-over-year in Q1’22 to 2,749k ounces. But Gold Fields’ removal drove most of that decline.
Subtracting GFI’s huge output from the comparable Q1’21, and replacing it with GDXJ’s then-26th-biggest stock’s, moderates the mid-tiers’ production decline to a far-milder 5.9% YoY. That’s still considerable, and worse than the GDX majors’ performance last quarter. Adjusted for another South-African major reporting late, the GDX-top-25 output retreated 3.7% YoY. Much of that weakness came from COVID-19-omicron.
Reading through these gold miners’ latest quarterly reports filed with securities regulators, early 2022’s latest COVID-19 wave really stuck out. In order to keep their mines open during the height of pandemic hysteria, the gold miners instituted extensive employee testing. Those programs are still in place, and generated widespread positive-test results on the fast-spreading but much-less-dangerous omicron variant.
GDXJ’s second-largest component stock Pan American Silver led off its entire Q1’22 results warning investors that “…our operations experienced high levels of workforce absenteeism in January and early February due to the Omicron variant of COVID-19. Workforce deployment is now back to more normal levels, and we are maintaining our guidance for 2022 with production weighted to the second half of the year.”
Plenty of other GDXJ-top-25 companies had similar disclosures, saying their Q1 outputs were adversely impacted by widespread positive COVID-19 tests. But nearly all of the affected also reaffirmed their full-year-2022 production guidances. With operations back up to full-speed with omicron passed, most of the smaller gold miners expect to make-up those early-year losses. So last quarter’s output declines are temporary.
In last week’s essay I analyzed the GDX-top-25 majors’ Q1’22 results. Many larger gold miners suffered the same COVID-19-omicron-driven workforce shortages, which similarly slowed their own operations. All that is in the rearview-mirror now, so this currently-underway Q2 ought to see a big jump in aggregate gold production from Q1. That should drive a return to year-over-year production growth among the mid-tiers.
Interestingly the ranks of true primary junior gold miners producing under 75k ounces per quarter swelled in Q1’22. Fully six of these GDXJ-top-25 stocks qualified, deriving over half their quarterly revenues from gold sales! Their productions are highlighted in blue above. That’s the highest concentration of actual juniors included in GDXJ’s upper ranks in years, since it was forced to shift from a junior ETF to a mid-tier one.
As gold stocks soared in price and popularity in 2016’s first-half, capital flooded into GDXJ to chase huge gains. GDXJ skyrocketed 202.5% higher on a 29.9% gold surge in just 6.7 months! GDXJ plowed that deluge of dollars into its holdings, threatening to run afoul of Canadian securities laws on some juniors. Once any investor including ETFs accumulated 20%+ stakes there, they were legally deemed takeover offers!
While GDXJ was a passive shareholder with no intention of managing operations, it diversified away from juniors to comply with that archaic rule. Ever since mid-tiers were added crowding out the juniors’ overall weightings, GDXJ and GDX have had large overlap in holdings. Fully 21 of these GDXJ-top-25 stocks are also in GDX, accounting for 22.5% of its total weighting. And 11 of these stocks are also GDX-top-25 ones.
GDXJ starts with the GDX component list, slices away its dozen-biggest holdings dominated by larger majors, then ups the rest to higher weightings. The GDXJ-top-25 gold stocks were mostly clustered between the 13th- to 34th-biggest rankings in GDX this week. GDXJ is effectively a subset of GDX, but a superior one since it excises the majors’ deadweight. Their outputs and market caps are way too big to grow fast.
The dozen biggest GDX holdings not included in GDXJ averaged massive 514k-ounce Q1’22 production and $22.7b market capitalizations last week! Meanwhile the GDXJ top 25 averaged merely $2.5b market caps and 115k ounces of quarterly gold output despite being mostly a GDX subset. Coming from much-smaller bases leaves the mid-tier and junior gold miners way-bigger potential gains than the far-larger majors.
These sweet-spot-for-upside-potential mid-tiers and juniors usually only operate a few mines at most, so occasional expansions and relatively-affordable mid-sized mine-builds really boost their outputs. That helps them overcome depletion to consistently grow their production on balance. Meanwhile most of the majors have struggled with shrinking production for years, unable to find enough gold and buy enough mines.
Long-term gold-stock price levels ultimately depend on miners’ profitability, which is directly driven by the difference between prevailing gold prices and gold-mining costs. In per-ounce terms these are generally inversely proportional to gold production. That’s because gold mines’ operating costs are largely fixed during planning stages. Their designed throughputs limit the amounts of gold-bearing ore they can process.
That doesn’t change quarter-to-quarter, and requires about the same levels of infrastructure, equipment, and employees. The only real variable is the ore grades run through the fixed-capacity mills. Richer ores yield more gold ounces to spread the big fixed costs of mining across, lowering unit costs which boosts profitability. With COVID-19 hitting Q1’22 output, the GDXJ top 25 should’ve reported higher unit costs.
Cash costs are the classic measure of gold-mining costs, including all cash expenses necessary to mine each ounce of gold. But they are misleading as a true cost measure, excluding the big capital needed to explore for gold deposits and build mines. So cash costs are best viewed as survivability acid-test levels for the mid-tier gold miners. They illuminate the minimum gold prices necessary to keep the mines running.
These GDXJ-top-25 gold miners’ average cash costs surged 8.6% YoY to $894 per ounce, the highest on record! That’s still way below prevailing gold prices, and a reasonable jump given lower outputs and the mounting impacts of inflation on mining costs. Along with COVID-19 absenteeism, higher input prices was another common theme in these latest quarterly reports. First Majestic Silver’s had a good example.
AG warned that “Not only was Mexico hit hard with the Omicron COVID-19 variant which significantly reduced personnel and production rates across our operations, we experienced increasing inflationary cost pressure across the operating portfolio for reagents and consumables such as diesel, cyanide and grinding media.” Costs spiraling out of control at one of its mines in particular really skewed GDXJ-top-25 results.
Long a major silver miner, First Majestic has joined its peers in increasingly diversifying into gold which has superior economics. About a year ago, this company bought its first dedicated gold mine in Nevada. Its costs have proven crazy-high since, including the eye-popping $2,120-per-ounce cash costs it suffered last quarter! Excluding that extreme outlier, the rest of the GDXJ top 25 averaged better $829 cash costs.
All-in sustaining costs are far superior than cash costs, and were introduced by the World Gold Council in June 2013. They add on to cash costs everything else that is necessary to maintain and replenish gold-mining operations at current output tempos. AISCs give a much-better understanding of what it really costs to run gold mines as ongoing concerns, and reveal mid-tier gold miners’ true operating profitability.
Impressively despite weaker production, the GDXJ top 25’s average AISCs only climbed 6.8% YoY to $1,211 per ounce. That’s also a new record high, but not greatly above the prior-four-quarter average of $1,141. Remember adjusted for that massive Gold Fields getting kicked out of GDXJ, these elite mid-tiers’ Q1’22 production slumped 5.9% YoY. So only 6.8%-higher AISCs in raging inflation is quite an achievement.
And those were also skewed high by First Majestic’s troubled gold mine, which reported insanely-lofty AISCs of $2,488 last quarter! Remove that anomalous distortion, and the rest of the GDXJ-top-25 gold miners averaged just $1,141 in Q1’22 which was right at that preceding year’s average. The mid-tier and junior gold miners are really holding the line on costs. And those ought to retreat again as production recovers.
Interestingly these companies also see AISCs improving as 2022 marches on. Other than Centerra Gold which saw anomalously-low $395 AISCs last quarter, 16 other GDXJ-top-25 companies reporting Q1 AISCs also have 2022 guidances on those. On average their outlooks see full-year AISCs running 4.5% under Q1 levels. Even First Majestic is forecasting greatly-improving $1,555 AISCs for its vexing gold mine.
The majority of these elite mid-tiers expect their 2022 production to be weighted to the second-half. Even in normal years without virus testing and severe price inflation, Q1s often prove output troughs. Like over 2/3rds of the world’s land mass, most of its gold mines are located in the northern hemisphere. There Q1s’ winter months consistently suffer the coldest-and-wettest weather conditions, impairing operational efficiencies.
Miners often schedule annual maintenance during those dark slow months, which can temporarily pause ore processing. According to the latest global gold fundamental data from the World Gold Council, during the last 12 years worldwide gold mine production soared an average of 4.6% sequentially from Q1s to Q2s! So this current quarter’s jump after the COVID-19-omicron wave’s passing should prove even bigger.
Even with those AG-distorted $1,211 average AISCs last quarter, the mid-tier and junior gold miners are still very-profitable. In Q1’22 the average gold price climbed 4.8% YoY to $1,879, the second-highest on record after Q3’20’s $1,912. Subtracting GDXJ-top-25 AISCs from quarterly-average gold prices is the best proxy for mid-tier unit earnings. That worked out to hefty $667-per-ounce profits last quarter, up 1.2% YoY.
Those are the best unit earnings the smaller gold miners have achieved since Q2’21, slightly ahead of the prior-four-quarter average of $657. And those Q1’22 unit earnings were also skewed low by those crazy-high costs at First Majestic’s gold mine. If the adjusted AISCs excluding that are used instead, the rest of the GDXJ top 25 earned $738 per ounce last quarter! That would’ve impressively been the third-highest ever.
The mid-tier gold miners themselves see full-year-2022 AISCs running about 5% below their Q1 levels. Lower mining costs will make for fatter profits going forward. And despite getting sucked into that serious stock-market selloff between mid-April to mid-May, gold is very likely to resume powering higher again too. History has proven nothing is more bullish for gold investment demand and prices than raging inflation.
This profligate Federal Reserve mushroomed its balance sheet an absurd 115.6% or $4,807b higher in just 25.5 months into mid-April! Effectively more than doubling the US money supply left far more dollars chasing and bidding up the prices on relatively-much-less goods and services. Serious inflation is going to fester until the Fed unwinds the majority of that epic QE4 money printing, which will take years if it ever happens.
The last similar inflation super-spikes erupted during the 1970s. Gold prices nearly tripled during the first, then more than quadrupled during the second! Contrary to gold-futures speculators’ paranoia, Fed-rate-hike cycles are little threat to gold either. In this modern monetary era since 1971, the Fed has completed a dozen before today’s. Gold’s average gains through the exact spans of all 12 of those ran a strong 29.2%!
Fed tightenings have proven so bullish for gold primarily because they are so bearish for stock markets. As of mid-week, the S&P 500 has already rolled over 18.2% at worst since early January on the threat of accelerating rate hikes and quantitative-tightening monetary destruction. The bigger this stock-market selloff grows, the longer inflation stays high, and the more the Fed tightens, the more bullish gold’s outlook.
Gold stocks tend to outperform their metal so well during its uplegs partially because of their big profits leverage to gold. Higher gold prices coming will fuel much-higher earnings among the mid-tier and junior gold miners, helping catapult their stock prices way higher. So the smaller gold miners’ own fundamental outlooks remain very-strong. Their stocks certainly didn’t deserve to get crushed with the stock markets!
On the hard-accounting front, the GDXJ top 25’s total revenues slipped 1.0% YoY to $5,948m in Q1’22. That jibes with 5.9%-lower gold production ex-GFI and 4.8%-higher average gold prices. These mid-tiers’ bottom-line accounting earnings surged 31.1% YoY to $836m, which is awesome. But like usual that was skewed by some huge unusual items. Buenaventura and Eldorado Gold reported those in this latest quarter.
BVN declared an enormous $480m gain selling discontinued operations, while EGO suffered a gigantic $365m impairment loss in preparation to sell a non-core gold asset. Net these out, and GDXJ-top-25 earnings last quarter rose closer to 13% YoY. That’s still pretty good, and quite the disconnect from the universal hate plaguing gold stocks after their recent plunge. Their traditional valuations are relatively-cheap too.
In classic trailing-twelve-month price-to-earnings-ratio terms, the GDXJ top 25 averaged 39.4x mid-week. Yet without the outlier MAG Silver which is in the hundreds as its maiden silver mine ramps up, the rest of these mid-tiers and juniors averaged a much-better 27.3x. That’s among the lowest aggregate valuation reads for the smaller gold miners in these last 24 quarters where I’ve been advancing this research thread.
The GDXJ top 25’s total cash flows generated from operations fell 36.5% YoY to $1,044m last quarter. Coping with fewer employees through that COVID-19-omicron wave was a big factor. Still these elite mid-tier and junior gold miners’ total cash hoards remained unchanged at $9,346m. So they continue to have big cash warchests available to expand their operations and keep growing their outputs on balance.
The smaller gold miners are also prime acquisition targets for the majors, since those perpetually struggle to offset ongoing depletion from their large-scale operations. Building occasional new mines isn’t enough either, so most of majors’ growth comes from buying out entire mid-tier and junior gold companies. Those offers usually arrive at nice premiums, offering more upside for contrarians deploying capital in these stocks.
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The bottom line is the mid-tier and junior gold miners of GDXJ generally reported a good quarter. Their overall production did slump in Q1’22, but the COVID-19-omicron wave driving that has passed. Despite lower outputs and severe price inflation, they still largely held the line on costs. That fueled strong earnings, in both per-ounce and bottom-line terms. Those profits are likely to grow substantially in coming quarters.
Most of the GDXJ-top-25 gold miners are forecasting growing production and lower costs throughout this year. And gold prices are likely to resume trending higher on balance with inflation raging and the stock markets rolling over on aggressive Fed tightening. Gold and its miners’ stocks are the best places to be invested in this extraordinary time. Their recent plunge and bombed-out prices aren’t fundamentally-justified.
Adam Hamilton, CPA