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 come 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 can follow me and receive that report.
In this analysis, we will calculate the real costs of production of Yamana Gold (AUY), a mid-tier producer primarily focused in South America with mines in Brazil, Argentina, Mexico, and Chile. The projects in Argentina have a higher element of political risk, which is something investors should note, but that is outside the scope of this article; investors interested in AUY should keep tabs on the political situation in Argentina.
Calculating the True Mining Cost of Gold - Our Methodology
In a previous article about Goldcorp's (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 AUY - 4Q 2012 and FY2012
Now let us use this methodology to take a look at AUY's results and come up with their 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 ratio of 52.7:1 and a copper ratio of 480:1. 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 appropriately represent the by-product conversion.
Important Note: When calculating gold equivalent ounces, our gold equivalent production may differ a little bit from AUY's numbers. The reason is that even though we are using the same base numbers, depending on the ratio of conversion, it may change the number of total equivalent ounces. We believe our use of the most recent LBMA prices is the most accurate in terms of predicting future gold equivalent production. It also allows investors to compare AUY with other gold companies because by using our methodology the comparisons will be apples-to-apples, while using individual gold miner calculations may yield much different results since each miner may use a different equivalency calculation (there are no GAAP gold equivalency calculations).
Also, when analyzing AUY's report, they do NOT include copper production in their calculation of gold-equivalent ounces, so their gold-equivalents will be significantly lower than the gold-equivalents specified in our calculations. They do not use it as gold equivalent, but they do subtract it when calculating their per ounce production costs - it is just a different way to arrive at the same goal.
Observations for AUY Investors
The first thing that investors should take note of is that the costs to produce an ounce of gold (after excluding write-downs on projects and investments) for AUY was $1247 for 2012 and $1106 for 4QFY12. The yearly average of $1247 seems to be rather average for the industry (GG had a cost of $1082, Barrick Gold (ABX) $1277, and Agnico-Eagle (AEM) $1343), but their fourth quarter production number of $1106 per ounce was very good. It is not clear if this drop in production costs was temporary or something more permanent, but 1QFY13 should give us a much better idea of the nature of the fourth quarter drop in costs. But it is always better to see fourth quarter costs dropping as opposed to rising, so investors should look at this in a positive light.
In terms of production, AUY had an excellent fourth quarter. They increased gold production by 20% and gold-equivalent production by around 10% on a year-over-year basis. On an annual basis, AUY increased its gold production by 10% and its gold-equivalent production by around 5%, with the drop in byproducts (silver and copper) neutralizing the gains in gold production. These are very good numbers for gold investors, because AUY is increasing gold production when most of its competitors are producing less gold ounces on an annual basis (both GG and ABX produced fewer gold ounces) and those competitors are forced to make up for it with increased byproduct production (gold-equivalent ounces).
Finally, investors should note that the 4Q production numbers of gold and gold equivalent ounces seem to suggest that AUY is on pace to increase production for 2013. For example, the gold production of 276,000 ounces for 4QFY12 would lead to FY13 production of around 1.1 million ounces if they maintained these production levels for the full year. Obviously there are other factors involved in predicting future production numbers, but it is definitely a good sign that the pace is where it needs to be to hit 2013 increases.
AUY's fourth quarter and annual reports were both very good and encouraging reports. Management showed that it was able to do a decent job controlling costs on an annual basis, with their $1247 true cost of production in the middle of the gold miner cost range. AUY did an excellent job in the fourth quarter, with production costs dropping to $1106 per gold equivalent ounce - which is extremely good. In addition, production numbers were up both quarterly and annually, and the rise in their gold production was significant, since most other miners were having a tough time simply maintaining their gold production - as opposed to increasing it, as AUY is doing.
There are a number of factors that investors need to consider with AUY, but on a true cost of production basis, AUY is a miner with decent costs and a good upside if management can follow-through on a very good fourth quarter.
For investors interested in gold as a commodity (GLD investors take note), AUY's report is another example of the increasing production costs that we are seeing in the gold mining industry. Even with the good fourth quarter, AUY's annual costs are still at $1250, which leaves a low margin at current gold prices. Though gold differs from other commodities in that it is more similar to a currency and thus may not be as driven by production costs as other metals, lowering production margins across the industry may limit supply and add to the bullish case for gold investors.