A company where copper is as good as gold

New Gold Inc. is, as its name suggests, a gold miner. But it's another metal, copper, that plays a large role at the company – perhaps larger than a casual investor might suspect.

How so? New Gold's New Afton mine, west of Kamloops, B.C., produces twice as much copper than gold, in dollar terms. That allows New Gold, quite legitimately, to report extraordinarily low company-wide mining costs, much lower than at its properties where gold dominates.

The role of copper at New Gold offers a window into how "byproduct accounting," as it's called, can impact miners' financial statements. And it raises an important point for New Gold's shareholders: To evaluate the company's prospects going forward, it's essential to keep an eye not only on the bullion that gives the company its name, but on the lesser metal that provides New Gold much of its cost advantage.

To be clear: The copper factor is not hidden. Investors can plainly see the effects by carefully reviewing the miner's reports.

New Gold released its preliminary 2014 numbers earlier this month, with full results to come Feb. 20. New Gold reported all-in sustaining costs (AISC), a number designed to capture the true long-term cost of mining, of $845 (U.S.) per gold ounce in the fourth quarter.

When broken out per property, there was a wide variance: Its Mesquite property in Arizona reported AISC of $1,090, while its Australian Peak Mines and its Mexican property Cerro San Pedro reported AISC of $1,231 and $1,447, respectively, both above the price of gold in the quarter. (See table for more detail.)

New Afton, however, reported AISC of negative $560 in the quarter, sharply decreasing the company's average number. That overall cost figure is something the company emphasizes: Its Feb. 4 news release said the 2014 results meant it was "solidifying its low-cost position" in the mining industry.

How can a company report negative costs at a mine? The answer lies in the industry's preferred method of "byproduct accounting." When a mine produces more than one metal, the company chooses which one is the predominant product. Then, it expresses the mine's costs in terms of ounces (or pounds) of that primary product.

The revenue from all other salable products at that mine, then, is used as an offset against the costs. "It looks at things through the lens of the primary product you're producing and remeasuring everything else in line with that product's units," says Jorge Beristain, a mining analyst for Deutsche Bank. (He does not cover New Gold.)

Mines where the byproduct makes up a significant amount of production by revenue – or even a majority – can drive the costs into negative numbers. That's the case at New Afton, where the 25,300 ounces of gold mined in the fourth quarter generated about $30-million in revenue, using New Gold's average realized price of $1,188 per ounce. The 20.4 million pounds of copper generated about $60-million in revenue, assuming New Gold's average realized price of $2.92 per pound.

To be clear, New Gold is not the only miner to benefit from this accounting. Goldcorp, for example, reported AISC of $595 in 2013 and negative $395 in 2012 at its Alumbrera mine in Argentina because it mined nearly as many pounds of copper as ounces of gold.

There are other choices for multiple-product mines that may be more suitable in other circumstances, but may also add to the confusion. Mr. Beristain notes Kinross Gold uses "gold-equivalent accounting" to translate silver sales into what the metal would fetch as ounces of gold.

And "co-product accounting" simply splits costs of a mine proportionate to the revenue from each mineral. It's best used when a single mine has a wide variety of products, none representing a majority.

In a June, 2014, report, analysts at Dundee Securities Ltd. examined the industry's costs using co-product accounting to make it easier to compare the companies. They found that co-product gold AISC numbers were $1,348 per ounce, $374 higher than AISC numbers calculated using byproduct accounting. "By categorizing revenues from non-gold production as a cost credit, the gold production cost profile of a company is distorted."

Randall Oliphant, New Gold's executive chairman, says his company is an industry leader in disclosure, noting that the Dundee report of last June recognizes New Gold and Goldcorp for being the only two of 18 companies the firm covered to report an AISC number that is closest to the definition created by the World Gold Council. (Mr. Oliphant, a chartered accountant, is chairman of the council.)

Mr. Oliphant says it makes sense for companies that present themselves as a miner of one product, primarily, to present sales of other products as a credit. And he presents a simplified example of the concept: "If you go buy a case of beer and you're going to get 10 cents a bottle back, do you say the beer costs the total amount you paid when you went into the store, or do you look at a net cost after you return the bottles?"

What this means for New Gold, however, is that its near-term future depends nearly as much on copper prices as gold, no matter what it has chosen as its primary product. And with copper down 20 per cent since last summer, that's a sobering prospect for New Gold shareholders.

Analyst John Bridges at JPMorgan says the company's cash flow is needed to build its Rainy River mine in Northwestern Ontario, making it "more sensitive to swings in metals prices." New Gold's shares underperformed the NYSE Arca Gold Bugs Index of miners from Jan. 5 to Feb. 4 by 30 per cent in part because copper prices fell by 11 per cent during that period, he says.

Mr. Bridges believes New Gold can spend $700-million at Rainy River over the next two years and still be liquid – as long as copper stays above $2.25 a pound and gold stays above $1,100 per ounce. At those prices, he says, the company "would have virtually zero liquidity by the end of 2016, assuming no asset sales." (The most traded copper and gold futures contracts closed Friday at $2.605 a pound and $1,227.10 an ounce, respectively.)

It means the metal that makes New Gold a low-cost producer could also provide the company – and its investors – with headaches.