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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 Goldfields Limited (NYSE:GFI), a major gold producer with copper byproduct that owns operating mines in Australia, Ghana, Peru and South Africa.

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 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 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 GFI - 1Q13 and FY2012

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

(click to enlarge)

*These quarters have been restated to reflect Sibanye spin-off

Important Notes about True All-in Costs Table

GFI spun off a number of its operations into Sibanye Gold and thus had to restate prior quarter costs and gold production. We have included the restated numbers for Q4FY12, Q1FY12 and Q1FY13, but the FY2011 and FY2012 are the old calculations. That means any comparisons between the restated and old numbers will have discrepancies and should only be done with that knowledge. As the company restates prior periods we will update the quarters and the all-in costs table.

Observations for GFI Investors

True Cost Figures - GFI's true all-in costs for Q1FY13 were $1557.86 per gold ounce, which was lower on a year-over-year basis, but was flat compared with Q4FY12. Since FY2011 and FY2012 years have not incorporated the restatement we will not compare them in detail, but we do expect FY2013 costs to rise compared to FY2012.

Compared to competitors, GFI is a much higher cost producer and compares to competitors such as Yamana Gold (AUY) (costs just over $1,300), Randgold (GOLD) (costs just under $1,200), Allied Nevada Gold (ANV) (costs just under $1,000), Iamgold (IAG) (costs around $1,400), Goldcorp (GG) (costs just under $1,200), Silvercrest Mines (SVLC) (costs below $1,100), Kinross Gold (KGC) (costs just under $1,400), Alamos Gold (AGI) (costs under $1,100), Newmont Gold (NEM) (costs around $1,300), Agnico-Eagle (AEM) (costs around $1,400), and Barrick Gold (ABX) (costs around $1,200).

Obviously when analyzing the numbers, GFI appears as one of the higher cost gold miners in the world, which is something management recognizes and is in the process of remedying. The Sibanye gold spinoff was one part of this plan, but management is also focusing on reducing costs by reducing production of all high cost ounces, which is what we are seeing in the drop in production. We believe this is the right approach for gold miners to take, but judgment is still forthcoming on whether management will be successful in making a meaningful reduction in true all-in costs.

Corporate Liquidity - Liquidity is very important for investors to monitor in this current low-price gold environment, especially for producers that have true all-in costs above the current spot gold price. GFI had $568 million in cash and deposits and another $277 million in investments. This may be of a concern for investors if gold prices stay at current levels for an extended period of time, but at this point GFI still has enough liquidity to produce gold at negative true all-in costs for a good amount of time. Though we would be very interested in seeing the Q2FY13 report to see cash drain in a quarter of much lower gold prices than Q1FY13.

Production Numbers - Production numbers are tricky with GFI because of the accounting restatements, so we will be strictly comparing quarterly performance.

Gold production dropped on a year-over-year basis from 458,400 gold ounces to 440,900 gold ounces, which is about a 5% drop in gold production. On a sequential basis, gold production dropped from 488,100 to 440,900, which was a much more significant 10% drop in production. Though we are not surprised at the drop in production because one of the focuses of management is to drop costs which will be done by cutting out production of non-profitable or borderline ounces. Management has forecast production of 1.8 to 1.9 million gold-equivalent ounces for FY2013, and based on first quarter production totals of 475,000 gold-equivalent ounces it remains on target to meet this production target.

Conclusion

On a true all-in costs basis, GFI's Q1FY13 production costs were one of the highest in the industry. At $1557.86 per gold-equivalent ounce, management needs to do a much better job of lowering costs to make the company profitable at current gold prices - though we would cut them some slack because when it comes to mining the geology determines a great majority of the costs so there is only so much that a company can do to lower costs.

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