In an earlier article, we 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, we 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.
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 this discussion is outside the scope of this article. Nevertheless, investors interested in AUY should keep tabs on the political situation in Argentina because events there may significantly impact the future of AUY's operations in that country.
Calculating the True Mining Cost of Gold - Our Methodology
In the previously mentioned article, 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.
Explanation of Our Metrics
Cost Per Silver-Equivalent Ounce - is the costs incurred for every payable silver-equivalent ounce. It is Revenues minus Net Income, which will give an investor total costs. We use payable silver and not produced silver, because payable silver is the silver that the miner actually keeps and is more reflective of their production. Miners also use payable silver and not produced silver when calculating their cash costs, so this is pretty standard.
We then add Derivative Gains (or minus Derivative Losses), which will give investors total costs without the effects of derivatives. Finally, we add Foreign Exchange Gains (or minus Foreign Exchange Losses) to remove the effects of foreign exchange on the company's costs.
Cost Per Silver-Equivalent Ounce Excluding Write-downs - is the above-mentioned "Cost per silver-equivalent ounce" minus Property/Investment Write-downs and Asset Sales. This provides investors with a metric that removes exceptional gains or losses due to write-downs and asset sales.
Cost Per Silver-Equivalent Ounce Excluding Write-downs and Adding Smelting and Refining Costs - is the above-mentioned "Cost per silver-equivalent ounce excluding write-downs" adding in smelting, refining and all other necessary pre-revenue costs. This is a new metric that we are now introducing to our true all-in cost series because it will more accurately measure all-in costs and allow comparisons between miners.
Most investors are unaware that many miners will remove smelting, refining, and other costs BEFORE reporting their total revenues figures and it will not be present in the income statement. The result of this is that it skews all-in costs higher for miners that refine themselves or include the costs in their income statement, while inaccurately showing lower costs for miners that remove it before reporting revenues.
A simple test can be done on any miner to see if there are any pre-revenue costs that are not reported in the income statement. Simply take payable production and multiply it by average realized sales price and this should come relatively close to the total revenues figure. If it gives you a number much higher than reported revenues then there are pre-revenue costs that are not being reported.
This line should alleviate these issues and allow comparisons on a fair basis.
True Costs of Production for AUY
Let us now 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 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 into 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 acknowledge 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.
Note about Adjustments to True Costs Values for AUY
We had to make a minor adjustment to our true costs numbers for AUY from previous releases for FY2012 and Q4FY12. These adjustments were made to remove Foreign Exchange gains and losses and also some minor changes to copper production numbers. The table above shows the correct numbers for AUY from previous years and quarters.
Observations for AUY Investors
The first thing that investors should notice is that AUY's true all-in costs rose significantly on a sequential and year-over-year basis to $1325. Even when excluding pre-revenue refining and smelting costs (which were exceptionally high in the first quarter), costs rose significantly. Though we would remind investors that costs in the gold mining industry have been rising across the board and AUY's costs are in the middle of the pack for the industry - they are higher but they also started at a lower basis than other miners.
Since true all-in production costs are close to the current gold price, investors have to analyze the liquidity of the company to make sure that it can survive if prices still keep on dipping. With $343 million in cash and cash equivalents and $237 million in inventory, AUY should not give investors any concerns in regards to their liquidity.
In terms of gold production, AUY increased gold production on a year-over-year basis by about 5%, which was slightly negated b reduced copper production, which isn't bad. But on a sequential basis, AUY suffered a significant drop in both gold and copper production. Management does expect gold-equivalent production to increase in 2013 by 20% over 2012's total due to the full-year production of their Mercedes mine, and ramp-ups in three other mines. Though we do caution investors, these production decisions were made before the April sell-off in precious metals and may be significantly cut if management begins aggressively cutting costs. Pay attention to the second quarter report which should provide more details on cost cutting measures.
AUY's costs rose in the first quarter significantly over the previous quarters and 2012 annual cost. Production increased on a year-over-year basis, but dropped sequentially and management will have to step up production to meet their previous production outlook - but they expect ramp-ups from other mines to make up the majority of the 2013 increase in production. Investors should pay close attention to the second quarter report to make sure that true all-in costs begin to fall with increased production.
AUY's report is another positive report for GLD and PHYS investors because it shows that miners are still not able to bring down production costs, and for Yamana Gold costs are still rising. With the recent April sell-off, many management teams are looking at ways to cut costs which include cutting low-grade production. We expect to see falling gold production across the industry (especially if gold prices stay in the $1300-$1400 range) and this will mean lower supply even as physical demand is rising. Investors should continue to accumulate gold as its costs of production are rising, while its production is falling.