In my earlier article, I discussed one of the most important metrics to analyze the gold industry, the actual cost of mining an ounce of gold, which can help an investor figure out whether it is time to buy GLD and/or the gold miners. In that analysis, I used the FY2012 financials to calculate the combined results of publicly traded gold companies and come up with a true all-in industry average cost of production to mine each ounce of gold.
First quarter results are starting to come in for gold miners, and investors should look to see if the gold mining industry can be successful in lowering production costs to remain profitable at the current gold price.
In this analysis we will calculate the true costs of production of Barrick Gold (NYSE:ABX), one of the largest gold producers in the world. ABX produces gold and copper in four continents (North America, South America, Australia, and Africa) and is an important indicator of mining production and costs since it is the largest gold producer in the world.
Calculating the True Mining Cost of Gold - Our Methodology
In a previous article about Goldcorp's (NYSE:GG) true costs 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 total 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 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 long-term floor may exist for gold or silver. The price may fall below this floor (as has happened in the past) but it would be very difficult for production to continue for long periods of time below the true all-in costs of production.
True Costs of Production for ABX - 4Q 2012 and FY2012
Let us use this methodology to take a look at ABX's results and come up with the true cost figures for each ounce of ABX's production. 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 which results in a copper-to-gold ratio of 480:1 pounds-to-ounces.
Note: ABX restated its previous results so we had to readjust our calculations for the previous period. The restatement had a minor impact on true all-in costs, but it accounts for the difference in our previous value for true all-in costs.
The first thing that investors should notice is that ABX management was able to control production costs for Q1FY13 and keep them to a mere 1% rise year-over-year - which is relatively in-line with previous Q1 costs. Additionally, the $1215 all-in value for Q1FY13 costs that ABX achieved in the first quarter is lower than the total 2012 figure of $1276, which is a good start to the year for ABX.
Though we would caution investors that ABX has reported good cost figures for the last few first quarters, with subsequent quarterly rises in costs, so we would need to see a good second quarter to really feel that ABX management has structurally cut costs. ABX does predict costs to rise for the rest of the year anywhere from 5-12% from this quarter's numbers, so we expect true all-in costs to be around $1300 for the rest of the year, which would put FY13 costs around 1% higher than FY12 costs - a marked improvement from the 5-10% cost increases that the gold industry has experienced over the last years.
It also seems like management's cost cutting is coming at the expense of gold production because first quarter production was down about 5% year-over-year, with increased copper production balancing this out on a gold-equivalent basis. This is not surprising to us and we expect to see companies across the industry focus on lowering costs at the expense of gold production. This is a positive for the industry and the gold price since it reduces gold supply and can help buoy the price of gold, and thus improve industry revenues.
Finally, first quarter production of 1.8 million ounces of gold and 127 million pounds of copper seem to fall in-line with ABX's FY13 production forecast of 7-7.4 million ounces of gold and 480-540 million pounds of copper. Without any major production issues (which is never a given in the gold industry) we believe that ABX can achieve the mid-range of its 2013 production targets.
ABX management's focus on cutting costs limited its Q1FY13 true all-in costs to a 1% gain and put their costs at $1215 per gold-equivalent ounce. This was a good job by management in containing costs, but they do forecast costs to rise for the rest of the year and we expect per ounce costs will be in the $1300 range for FY13. Finally, it seems that cost-cutting comes at the expense of production because ABX's gold production declined year-over-year. Investors need to monitor ABX's effectiveness in limiting costs because we believe that this will be a key performance metric for the industry in the upcoming year since total gold production should be falling in 2013.
ABX's report is positive news for GLD investors because it shows that miners are still not able to bring down production costs - even while cutting production. We expect to see falling gold production across the industry, especially if gold prices stay in the $1400 range since most first quarter performance plans incorporated much higher gold prices. Rising costs and lower production numbers continue to provide investors a compelling case to own gold, and we believe that investors who accumulate gold will do very well when gold sentiment turns positive.