In my earlier article, I discussed one of the most important metrics to analyze the silver industry, the actual cost of mining an ounce of silver, which can help an investor figure out whether it is time to buy SLV and/or the silver miners. In that analysis, I used the 3Q 2012 financials to calculate the combined results of a number of publicly traded silver companies and came up with the average cost it takes to mine each ounce of silver. Once the 4Q FY12 reports from all gold and silver miners are out, we will be posting the consolidated true production cost calculations for both gold and silver, so investors who are interested follow me and you will receive that report.
In this analysis we will calculate the real costs of production of Kinross Gold (NYSE:KGC), a mid-tier producer of gold and silver with operations that span the globe. They have operating mines in North America, South America, West Africa and Russia.
Calculating the True Mining Cost of Gold - Our Methodology
In a previous article about Goldcorp's (NYSE:GG) cost of production, I gave a thorough picture of the current way mining companies report their cost of production and why it is inaccurate and significantly underestimates costs. Then we presented a more accurate methodology for investors to use to calculate the true costs of mining gold or silver. Please refer to that article for the details explaining this methodology, and I would encourage all precious metals investors to understand this important concept.
It is important for investors interested in miners or those who focus on gold and silver as a commodity investment because the true costs of production will show where a possible floor exists for a commodity (the production cost) which is important to gold (GLD investors) and is also an obvious way to differentiate miners.
Real Costs of Production for KGC - 4Q 2012 and FY2012
Now let us use this methodology to take a look at KGC's results and come up with average cost figures. When applying our methodology for the most recent quarter and FY2012, we standardized the equivalent ounce conversion to use the average LBMA price for Q4FY12. This results in a silver-to-gold ratio of 52.7:1 and is what we used to convert silver production to gold. We like to be precise, but realistically minor changes in these ratios have little impact on the total average price - investors can use whatever ratios they feel most appropriate represent the by-product conversion. One thing to note is that KGC converts its byproducts based on the yearly price of the byproduct, so comparisons using their financial statements of gold equivalent ounces may be inaccurate. We strongly urge investors to convert them on a fixed rate when doing comparisons (which is what we have done) so that it paints a more accurate picture of the production numbers.
In addition, KGC's statements leave a lot to be desired in terms of transparency to investors. Many other gold companies will clearly list their quarterly and annual production of their equivalent ounces and their byproduct production. KGC does not do this so an investor has to dig through the statements to find byproduct production, and even that leaves a lot to be desired because it does not break it down in the same way that it breaks down equivalent production.
Since KGC does not list the financial statements specifically for the fourth quarter (or at least they are not accessible at this time), we had to painstakingly remove all the previous quarter's numbers to come up with the fourth quarter figures. What is strange is that these numbers oddly jump in the fourth quarter, even after removing the write-downs of the company's projects. We are not sure if this is done to hide costs or if this truly is a large jump in fourth quarter costs - either way we did our best to compile the numbers and come up with estimates for the cost of production.
Observations for KGC Investors
The first thing that investors should take note of is that the costs to produce an ounce of gold for KGC jumped significantly in 2012 versus 2011, from $1088 to $1472 per gold equivalent ounce. This jump comes even after excluding the company's write-downs, and is significantly larger than the cost increases other miners experienced in 2012. Additionally, at $1472 an ounce, it is very close to the current gold price (around $1570 at the time of this writing) and is much higher than other gold competitors. For example, GG had costs of $1082, Barrick Gold (NYSE:ABX) had costs of $1277 and Agnico Eagle (NYSE:AEM) had costs of $1343 as their annual total costs of production for 2012 - so KGC is producing gold a lot more expensively than these two competitors. This may be related to a temporary increase in costs, but definitely something to note.
In terms of production, KGC production stayed relatively flat for the year, though fourth quarter numbers look like they are increasing a bit. On a yearly basis, it looks like silver production is clearly declining, but since KGC is primarily a gold miner this should not be something that would be of too much concern to KGC investors who buy it primarily for its gold exposure.
Finally, investors should note that the costs without excluding write-downs are tremendously high in both 2012 and 2011. The value of seeing the costs of production including write-downs is demonstrated with KGC, because if an investor simply looks at the costs of production excluding write-downs it may seem KGC made a little bit of money producing gold at $1472 and selling at the average yearly price which was above that. But the fact of the matter is that KGC lost money in both 2012 and 2011, and had to finance itself primarily through debt - raising over $1.5 billion in debt in 2011 and 2012.
KGC does not have a lot of room for gold prices to drop further before they have a serious financial crunch, if they are not already experiencing a cash crunch. They either have to significantly cut costs (which other miners have not been able to do) or they have to increase production through development.
We stress that this analysis is simply based on production costs and does NOT take into account development projects that are coming online in future quarters. If KGC can bring online new projects, they may still be a company that can return to profitability, but without these projects investors should be very careful before investing in KGC.
For investors interested in gold as a commodity (GLD investors take note), KGC's report is more evidence that the gold mining industry is severely stressed with margins at the current gold price. As I have stressed in previous articles, this is bullish for investors of GLD since investment dollars are not coming into the gold industry and miners have little room to allocate resources to anything other than survival.