A scan of major gold producers’ earnings suggests the cost of mining gold has risen dramatically over the past few years.
Part of that is a true increase, owing to inflation and the expense of digging out tough-to-reach grades. But most of it is due to a change in the cost metric that gold miners emphasize in their reports to the investing community.
For years, miners liked to talk about “cash costs,” the mine-level expenses of pulling an ounce of gold from the ground. For the most part, cash costs ran from $500 (U.S.) to $800 per ounce, depending on a miner’s properties.
There was a problem, however: Even as the price of gold skyrocketed to nearly $1,900 per ounce, miners weren’t reporting wild windfall profits on their bottom lines. That’s because cash costs left out a host of expenses, from the costs of running the company to annual spending on equipment.
The new “all-inclusive” measures attempt to solve that. The most frequently used metric, “all-in sustaining costs,” puts the cost of extracting an ounce of gold at more than $1,000 industrywide – and explains why miners are having a rough go at profitability when gold sells for a couple hundred dollars more than that.
“The old [cash cost] led to a lot of misunderstanding about the ability of cash flow that would be there for equity holders,” says Jorge Beristain, an analyst for Deutsche Bank.
“People aren’t really in the weeds on metrics and how they’re calculated, so when a company tells you, ‘Our cash cost is $600,’ and the price of gold is $1,200, you do quick math and say, ‘Hey, they must be earning $600 an ounce of cash flow.’”
“As the gold price went up, investors started to realize there was far less cash flow than they’d guesstimated using that [cash cost] as a simple metric. So there was increasing pressure on the industry to explain to all stakeholders where the cash was really going.”
The evolution could be seen over time at the Denver Gold Forum, one of the premier investment conferences for gold equities. In 2012, when few companies emphasized the metric, Nick Holland, the CEO of Gold Fields Ltd., strongly endorsed the measure.
“We sit here and talk about how wonderful our cash costs are, but at the end of the day, that’s only half the equation,” he said. “The real equation is look at the all-in costs. We stand up and talk about cash costs and how much money we’re making at the EBITDA level, but the real picture is, we don’t really make that much money.”
There was also a matter of self-interest, Mr. Holland said: Governments wondered why the royalties and taxes miners paid weren’t higher, if they were so profitable.
In June, 2013, the World Gold Council, an industry group, produced a detailed standard for what miners should include in all-in sustaining costs, or AISC.
And in this year’s gold forum, held this week, this measure was found in nearly every presentation from the major gold companies. Many still used “cash costs” at the individual mine level, but Barrick Gold reported all-in sustaining costs at each of its properties.
“AISC is the key metric we use when we talk about our operations, because it is a more accurate reflection of the true costs of mining,” Barrick spokesman Andy Lloyd said.
“I love the all-in sustaining costs metric,” Chuck Jeannes, the president and CEO of Goldcorp said at the forum. “I think it provides transparency that we need to show what it really costs to operate a mine. But we have to be aware, we don’t buy trucks or develop new [tunnels] every quarter, so those costs can be kind of chunky.”
Mr. Jeannes’s disclaimer raises a good point: Investors still need an understanding of what it includes – and what it doesn’t. Rather than use depreciation, an income-statement item that reflects the historical cost of a miner’s assets for the period, it pulls capital expenditures from the cash-flow statement. It allows a miner’s management to determine what part of the period’s capital spending is devoted to “sustaining” its existing operations, versus what is instead spent on “growth.”
“Because the companies have discretion on what they are going to spend in any particular year, and also what they are going to call growth capital versus sustaining capital, that measurement is very easy to manipulate,” says Adam Graf of Cowen & Co.
There’s also that more innocuous problem that Mr. Jeannes identified. Mr. Graf gives an example of a miner that needs to build a new facility in order to maintain operations at one of its sites.
“Let’s just say your cash costs for gold on that particular asset happen to be $900 an ounce. Well, if the miner had that big expenditure this quarter because they’re building a new tailings facility, the all-in sustaining costs for that particular quarter could be $1,800 per ounce. So then the natural sort of knee-jerk conclusion would be, ‘Oh, your all-in sustaining cost is $1,800 an ounce, and so with gold selling at $1,200 an ounce, you should be shutting down this asset.’”
But the high costs may exist only for a single year, Mr. Graf said, and the company could be rewarded with more production at a reduced future cost.
Mr. Beristain of Deutsche Bank says that as gold prices have decreased, miners have responded by cutting sustaining capex, research and development, and exploration costs. “Let’s pay attention to how the industry is achieving these cost cuts, because it matters if they’re coming on the sustaining side.”
Mr. Beristain also suggests investors remember that the “all-inclusive sustaining cost,” as well as the even more expansive “all-inclusive costs,” don’t actually include other expenses a mining company encounters, such as corporate income taxes and debt servicing, a particular problem in today’s highly leveraged mining world.
“That’s where AISC falls short,” he says. “You would look at today’s gold world and say, ‘Oh, $1,250 gold, $1,000 AISC, they’re clearing $250.’ Not really.”
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