In an earlier article, we showed investors how to calculate an "all-in" cost figure for producers that includes all costs related to mining silver. This is one of the most important metrics to analyze the silver industry, and allows investors to easily compare companies and see where a potential bottom lies in the silver price. We will now use the same methodology to calculate the "all-in" gold cost figures.
In this analysis, we will calculate the true costs of production of Eldorado Gold (EGO), a gold producer that owns operating mines in China, Turkey, and Greece. In addition, they own two base metal mines located in Brazil (an iron-ore mine) and Greece (a base metal mine). EGO also owns a few development projects located in China, Greece, Turkey, and Romania.
One thing that investors should note is that EGO owns development properties (and one operating mine) in Greece, a country with significant political risk. Investors in EGO should follow developments in Greece closely.
Calculating the True Mining Cost of Gold - Our Methodology
In a previous article about Goldcorp's (GG) per ounce cost of production, we gave a thorough overview of the current way mining companies report their costs 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 all-in 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 would be a good indicator of where a possible floor may exist for gold or silver.
True Costs of Production for EGO - 4Q 2012 and FY2012
Let us use this methodology to take a look at EGO's results and come up with the true cost figures for each ounce of EGO's production. When applying our methodology, we standardized the equivalent ounce conversion to use the average LBMA price for Q4FY12. This results in an iron-to-gold ratio of 14.35:1 iron tonnes to ounces of gold. Additionally, EGO mines a concentrate mix of lead and zinc at its Stratoni mine in Greece, and we converted this mix to gold at a 1.9:1 ratio of tonnes of concentrate to ounces of gold, which was based on the average yearly price for each sold tonne of concentrate. We like to be precise, but 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.
Observations for EGO Investors
The first thing that EGO investors should notice is that the costs to produce an ounce of gold, after excluding write-downs, were $1,122 per ounce for 2012 and $1,110 per ounce for the fourth quarter of 2012. This puts them close to the top of the industry in terms of all-in costs per ounce, with most competitors having higher all-in costs as GG had a cost of $1,082, Barrick Gold (ABX) $1,277, Yamana Gold (AUY) $1,247, IAG $1,377, and Agnico-Eagle (AEM) $1,343 for FY12. In addition, the fourth quarter, costs of $1,110 per ounce were exceptionally low for the industry and show that EGO is doing a very good job keeping a lid on costs. EGO management does forecast that cash costs will rise in 2013 anywhere from 8-10%, so investors should also expect the all-in costs to rise at the same rate. We would expect these costs to be around $1,250-$1,300 per ounce in FY13, which is still a good number for the gold industry.
In terms of gold production, EGO's production was relatively flat in 2012 with the increase in gold-equivalent ounces due to increased byproduct production. But management does expect total gold production for 2013 to be in the 700,000-750,000 range, and fourth quarter production of 190,000 ounces does seem to support EGO hitting the higher end of this gold production range.
The biggest risk for EGO investors is the significant political risk posed by operations in Greece. Not only is EGO's Stratoni mine located there, but it also has three major development properties in Greece. We do not believe the Greek political and financial crisis is over, and there is a significant risk that some or all of these properties could be affected by the turmoil there. Additionally, its $500 million Skouries mine is facing tremendous local opposition with some violent protests aimed at preventing the development of the mine. A loss of this or any other properties in Greece would materially affect EGO's reserves, and though the company should be diversified enough to overcome this loss, it would still have a major impact on the company and its share price.
EGO's fourth quarter and annual production true cost figures make the company one of the lowest cost gold producers in the industry. Management has done an excellent job controlling gold production costs, and though they expect costs to rise next year, they would still have a cost structure at the lower end of the industry, which would help them weather the current low gold price environment. The biggest risk for EGO investors lies in their Greek properties and the fact that the political situation in Greece is quite bad. If the Greek political situation improves, EGO would offer investors a very good opportunity to own a low-cost producer with operating mines in non-western jurisdictions.
For investors interested in gold as a commodity (GLD investors take note), EGO's report demonstrates that even the lowest cost gold producers are still producing in the $1,100 range, with EGO forecasting costs to rise a minimum of 8-10% for 2013. This means that costs of production are not far below the current $1550-$1600 gold price, and a fall below $1,000 per ounce will put even the lowest cost producers significantly in the red.
Aggressive gold investors should be accumulating on the drops, while conservative investors should be eyeing the $1200 to $1300 range as a very strong floor for the gold price, although we do not think that gold will drop to those levels. We believe the case for gold is bullish even without central bank intervention, because the costs of production are not far below the current gold price.