Thursday, August 8, 2013

Gold has become more precious. Mining costs up 14% CAGR since 2003 to $1,200 per ounce.

Gold Price and Cost Up 14% CAGR over last Decade
A deep dive in to the financials of several major gold mining companies reveals that gold has become dramatically more costly to extract over the last 8-10 years.  The All In Sustaining Cash Cost (AISC) per ounce at Barrick Gold, for example increased from about $250 per ounce in 2002 to $945 per ounce in 2012, which is a 14% compound annual growth rate (CAGR).  Coincidentally, market prices for gold have grown at 14% CAGR from $350 to $1,300 per ounce since 2003, as well.  Costs have grown as fast as sales price.  Miners were not able to expanded profit margins despite sales price almost quintupling.  Their stock prices have been punished accordingly because investors look to miners as a levered play on gold prices.

Current Cost of Producing Gold is $1,200 per Ounce
Barrick is the largest gold mining company and has many mines all around the world.  Currently Barrick has one of the lowest cost positions in the industry.  In their Q2 earnings report, Barrick forecasted 2013 AISC of $900-$975 per ounce.  <  slide #8>  The industry average ASIC is $1,200 per ounce according to data from TD Securities presented by Barrick.  <  slide #6>  The handful of major gold miners that I  analyzed have an average AISC of about $1,050 per ounce.

Cost Includes By-Product Credit and Excludes Project Capital
AISC is a new industry metric promoted by the World Gold Council whose members include gold mining companies.  The miners began voluntarily reporting AISC in 2013.  Some started earlier and most provide 2012 AISC when reporting 2013 quarterly result to enable comparison.  AISC excludes non-cash items such as depreciation, depletion, and amortization.  AISC includes an estimate of sustaining capital and excludes new project and development capital.  Sustaining capital is that required for gold production in that year.  In this way AISC is the total cash cost of recently mined gold.  Presumable, a mining company can continue to produce from current mines at the AISC until that mine is depleted.  AISC also includes the benefit of sales of by-products, such as silver, copper, lead and zinc. 

Cost Increase Due to Drop in Ore Head Grade
An investor new to the gold industry might rightly wonder how costs have increased so much.  Certainly, wages, diesel, tires, and electricity have increased over the years.  But, not 14% per year!  And the revenue from by-products has benefited from higher prices over the last decade which helps reduce total cost.   

The cost of gold production is up dramatically because yield, or ‘head grade’ as the industry calls it is down.   Head grades for the industry have dropped from 2.0 grams/mt to 1.5 grams/mt according to data from the Metals Economics Group and presented by Barrick. slide #5  Now the industry gets only 3 for the same effort that used to yield 4.  That’s 33% to the top line that would drop directly to the bottom line.  Today industry profit would be almost 80% higher if yields were still at decade ago levels.

Gold Production Volume is Flat
Lower head grades also explain why industry gold production volume is flat despite dramatic increases in capital spending that began several years ago when gold prices started taking off. 
Gold Mine Production
Metal Content in Kilograms
World (rounded)
World ex China and Russia

Let’s use Barrick as an example, again because they are typical for the industry.  In 2004-2007 capital spending was about $1.0B annually and production was about 8 million ounces.  Then capital spending is doubled, and then tripled, and then quadrupled yet production volume declines to 7.2 million ounces this year.  This is a long cycle business and capital spent today may not yield returns for years.  However, declining production volume clearly shows that gold has become more precious.

The scarcity of gold in the ground helps establish a floor for price in the long term.   That floor is now at about $1,200, which is almost 5 times more than in the early 2000’s.  Miner stock prices will appreciate when they can demonstrate operating leverage and increase profits faster than gold prices.  

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