Friday, March 1, 2013

Gold mine investors have gotten the shaft

As I wrote several days ago the gold miners have barely been able to increase production despite increased investment and higher gold sales prices over the last several years.  The 7 mining companies that I reviewed estimate that gold production in 2013 will increase only 2.3% from 2012.

Bloomberg published a nice summary of the situation. gold-miners-come-clean-on-costs-after-lost-6-years

Some comments on the Bloomberg article:

The article focuses on cost which should be viewed together with production or sales.  The most damning aspect of gold miner leadership is that their investments have not achieved increased production.  If ABX and GG were producing more gold, the investments would have a much better return since their all-in sustaining cost is currently $941 per ounce.  At this cost level continuing operating margins are over 40% assuming a gold sales price of $1,600 per ounce.  As an investor in gold mining companies I would be satisfied with lower margins (in percentage) as long as total operating profit (in dollars) is growing.

Barrick Gold Corp. (ABX) and Goldcorp Inc. (G), the two biggest producers by market value, have begun reporting “all-in sustaining costs” for the first time. The new measure averaged $941 an ounce between the two companies in the fourth quarter. That’s 50 percent higher than the $626 average so-called cash cost they disclosed in the preceding three months
The average cash cost of 10 of the biggest gold miners was $694 an ounce in the third quarter, 49 percent higher than in the same period two years earlier, according to data compiled by Bloomberg. The average gold price rose 35 percent in the same comparison.
Cash cost has been increasing mostly due to lower yields and partly from "pressure from rising prices for labor, equipment and raw materials".   New mines starting production have lower yields than the old mines that have been depleted.  And, ongoing mines are also seeing lower yields.  Lower  yields means that more fill must be excavated and more tons of ore milled to produce the same amount of precious metals.  At an underground mine it means that more and usually deeper and therefore more expensive tunneling is necessary just to reach ore deposits.

With an average cash cost of $694 per ounce the miners should be producing as much as possible - and I think they are.  There is a lot of room for production at lower yields if you sell something that cost $649 for $1,600.  Miner that can grow production will carry a premium valuation.

What exactly is cash cost and all-in sustaining cost?  Cash cost typically refers to cash cost by-product.  However, many mining companies also report cash cost co-product.  

Cash Costs by-product exclude depreciation and depletion and include:
- the cost of labor, equipment, spare parts and utilities
- the cost of royalties
- the cost of treatment and refining charges
- the benefit of by product sales, such as silver, copper, lead and zinc sales

Cash Cost co-product includes the same types of costs as for by-product.  The costs are allocated to each product (gold, silver, copper, lead, etc) separately.  In this way no profit on silver, copper, lead and zinc is included or benefits the co-product cost of gold production.  

All-in sustaining cost is defined as:
- cash cost by-product 
- sustaining capital
- exclcudes capital for new mines not yet in production
- corporate general and administrative
- exploration expense
- excludes reclamation and closure costs

The industry is currently working on standard definitions for all-in sustaining cost.  Many of the publicly traded mining companies have started reporting their own version of all-in sustaining cost.  All-in sustaining cost is a better measure of total profitability because it includes sustaining capital and G&A.  

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