Seeking Alpha
Long only, value, contrarian, gold & precious metals
Profile| Send Message|
( followers)  

Introduction

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 Randgold Resources (NASDAQ:GOLD), an African focused miner with operations in Mali, Senegal, the Ivory Coast, and a development project in the Congo. As an African operator GOLD faces significant country risk, but so far management has managed to negotiate these risks smoothly, but investors should pay close attention to political issues in Africa (especially Mali) but this is beyond the scope of this article.

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, which is an important concept for all precious metals investors to understand.

Explanation of Our Metrics

Cost Per Gold-Equivalent Ounce - is the costs incurred for every payable gold-equivalent ounce. It is Revenues minus Net Income, which will give an investor total costs. We use payable gold and not produced gold, because payable gold is the gold that the miner actually keeps and is more reflective of their production. Miners also use payable gold and not produced gold 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 Gold-Equivalent Ounce Excluding Write-downs - is the above-mentioned "Cost per gold-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 Gold-Equivalent Ounce Excluding Write-downs and Adding Smelting and Refining Costs - is the above-mentioned "Cost per gold-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 these pre-revenue costs are not reported 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.

Real Costs of Production for GOLD - 1Q13 and FY2012

Let us now use this methodology to take a look at GOLD's results and come up with their average cost figures.


(Click to enlarge)

*Incorporates accounting changes

Important Notes about True All-in Costs Table

GOLD changed the way it does it accounting as of Q1FY13 to account for the Kibali and Morila mines as joint ventures instead of joint operations. In layman's terms, the company is treating these mines as an equity investment and thus is including only its share of net earnings on its income statement.

This affects true all-in costs in two ways. First, this new method of accounting removes all revenues and costs associated with these projects, replacing them with only net income. Since we are interested in costs to mine gold, this would throw off the calculation because the costs are no longer included in the statement, thus we also have to treat this production as an equity investment and remove the attributed ounces of these mines form the calculation.

Here is an example to show why we have to remove these attributable ounces from the calculations. If a company produces 100 ounces of gold with a total cost of $500 and revenues of $1500, then its cost per ounce is $5 and its net profit is $10 per ounce or $1000 total ($15 in revenues minus $5 in profits).

If the company now changes its accounting method to account for half of production as an investment, it will remove both revenues and costs from its income statement and only report income from the project. So the company would now report total production of 100 ounces (same as before) with total costs of $250, revenues of $750, and net income of $1000. It would seem that costs are now only $2.50 per ounce - even though absolutely nothing has changed in terms of production costs. The difference is that costs and revenues have not been reported for these mines and only their net income is being added. Thus we have to remove those 50 ounces from our calculations, which will give us our correct $5 per ounce costs.

This is why we are removing Kibali and Morila production from our calculated attributable ounces for IAG. We will treat them as GOLD treats them, as an equity investment not as an operations segment - this will allow us to get the true cost of each ounce produced rather than skewing the numbers because of an accounting change.

The second consequence of this accounting change is that it has been applied to this quarter but not the previous quarters yet. So ounces produced for previous quarters in our table will still reflect old production (including Kibali and Morila) while the most recent quarter and Q1FY12 will remove these numbers. Unfortunately this will make it difficult for gold production comparisons until future income statements are released, but the true all-in costs should still be accurate and comparable.

Observations for GOLD Investors

True Cost Figures - GOLD's true all-in costs for Q1FY13 were $1171 per gold ounce, which was higher on a year-over-year basis, but that was to be expected since last year's first quarter's costs were extremely low for a major gold producer. On a FY2012 comparison, $1171 was slightly higher than the $1114 annual, but it was an improvement on Q4FY12 costs.

Compared to competitors, GOLD's performance was very good and it ranks as one of the lowest cost producers in the world, and compares to competitors such as Yamana Gold (NYSE:AUY) (costs just over $1300), Allied Nevada Gold (NYSEMKT:ANV) (costs just under $1000), Iamgold (NYSE:IAG) (costs around $1400), Goldcorp (NYSE:GG) (costs just under $1200), Silvercrest Mines (NYSEMKT:SVLC) (costs below $1100), Kinross Gold (NYSE:KGC) (costs just under $1400), Alamos Gold (NYSE:AGI) (costs under $1100), Newmont Gold (NYSE:NEM) (costs around $1300), Agnico-Eagle (NYSE:AEM) (costs around $1400), and Barrick Gold (NYSE:ABX) (costs around $1200).

Lower costs is one major advantage Randgold has by operating in Africa, but investors have to weigh that with the much higher political risk present in African countries.

Corporate Liquidity - Liquidity is very important for investors to monitor in this current low-price gold environment. At the end of Q1FY13, GOLD had $250 million of cash and cash equivalents, and another $500 million in other liquid assets with no debt. Ordinarily the combination of balance sheet cash and low-cost operations would give a company very good liquidity, but GOLD is also in the process of starting operations at its Kibali mine in the Congo. The costs are estimated to be around $700 million for 2013, but investors should continue to monitor liquidity as these capital expenditures are spent.

Production Numbers - Production numbers are a little tricky with GOLD because of the accounting change and the fact we are not including Kibali and Morila production in our base true all-in cost calculations. So what we will do is compare apples to apples and oranges to oranges- namely compare Q1FY12 and Q1FY13 together and then use Kibali and Morila numbers to compare yearly totals.

On a year-over-year basis, gold production numbers were up from 143,591 ounces to 183,594 ounces, which is an increase of around 30% - which is an excellent production increase. But on a sequential basis attributable production was down from 194,846 in Q4FY12 to 183,594 gold ounces.

Based strictly on first quarter numbers at producing mines, GOLD's production seems in-line with 2012's annual totals. But the company does expect its new Kibali mine to start producing at the end of 2013, so if this production can offset general production declines we may see a little boost in gold production for the year.

Conclusion

On a true all-in costs basis, GOLD's Q1FY13 production costs were very low for a major gold miner. At $1171 per gold ounce, the company ranks amongst the lowest cost gold producers in the industry - though investors have to remember that they do operate in Africa so lower costs must be weighed with higher political risks. But they are one of the few producers who can maintain positive true all-in cost margins even at current gold prices.

Corporate liquidity is good as spending continues on its new Kibali mine in the Congo, and investors can expect that production may increase by year-end if the company can keep that project on schedule. Finally, Randgold seems on pace to match and possibly exceed 2012's total gold production, which is something rare in the gold industry as many miners struggle to simply keep production flat. Investors looking for a quality gold miner with low-cost production should consider adding GOLD to their portfolio.

Source: What It Really Costs To Mine Gold: The First Quarter Randgold Edition