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 true costs of production of Barrick Gold (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 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.
True Costs of Production for ABX - 2QFY13
Let us now use this methodology to take a look at ABX's results and come up with their average cost figures. When applying the methodology for the most recent quarter and FY2012, we standardized the equivalent ounce conversion to use the average LBMA price for Q2FY13. This results in a copper-to-gold ratio of 436:1. Since our conversions change with metal prices, this may influence the total equivalent ounces produced for past quarters - which will make current-to-past quarter comparisons much more relevant.
Notes about true all-in costs table
ABX restated its previous Q2FY13 results so we had to readjust our calculations for the previous period. This restatement had a limited impact on Q2FY12 true all-in costs and resulted in all-in costs for that quarter declining to $1227 per gold-equivalent ounce from the $1246 reported previously.
Included in ABX's Q2FY13 results was a $9.3 billion write-down which tends to create abnormal taxes for the quarter. To normalize these numbers we have added two rows "Normalized Total Costs" and "Normalized Total All-in Costs".
Normalized Total Costs represents all ABX's costs for the quarter minus the $9.3 billion write-down; plus smelting and refining costs, plus estimated normalized taxes (previous quarter's taxes of $420 million). The big change here is related to taxes, if we use ABX's quarterly reported taxes (-$213 million) it will skew the true all-in costs to the displayed $2317.33 - this is because at -$213 million the write-down for the quarter should require a greater tax deduction than reported (not sure if ABX is saving the rest of this deduction for future quarters). The evidence of this is that in Q4FY12 ABX reported a $6.2 billion write-down and took a tax deduction of $1.5 billion - this quarter's $9 billion write-down should have generated a higher deduction. That is why to normalize the all-in costs we simply eliminate the write-down entirely and estimate ABX's taxes at the previous quarter's tax amount - not exact but it should be fairly accurate.
Normalized true all-in costs are simply Normalizes Total Costs divided by total gold-equivalent ounces. The $1295.11 number is very close to ABX's reported $1304 all-in cost number, so our numbers are within 1% of what the company is estimating its all-in costs.
True Cost Figures - Let us now take a look at ABX's true all-in costs figures. For the quarter, ABX reported true all-in costs of $1295 per gold-equivalent ounce. This was up about 5% from Q1FY13 ($1214), and up a slight 2% from FY2012 true all-in costs of $1274 per gold-equivalent ounce. What we seem to be seeing here is ABX getting a bit more control over costs, though since they are still rising there is still more we would like to see from management.
Additionally, ABX has been implementing cost-cutting measures to deal with the lower gold price so investors can expect to see the result of these measures over the next few quarters. We would expect costs to continue to lower (or stabilize) in Q3FY13; if they do not then this would probably be a very negative sign for the company - that even with cost-cutting measures costs do not go lower.
Though these costs may seem high, they are currently pretty in-line with many competitors' Q1FY13 costs. In terms of Q2FY13 costs, the competitors we have analyzed are similar in terms of their costs with Goldcorp (GG) (costs just over $1250), Alamos Gold (AGI) (costs just under $1250), Allied Nevada Gold (ANV) (costs just over $1300) - though obviously we have quite a bit more of gold companies to report and analyze to really get a feel for where ABX ranks.
Corporate Liquidity - Liquidity is very important for investors to monitor in this current low-price gold environment. At the end of Q2FY13, ABX had $2.4 billion in cash and cash equivalents and around $2.8 billion of ore and inventories (which may not be very liquid). This liquidity should be sufficient for ABX's current mining costs and expenditures, but investors should monitor this situation because ABX expects to be cash flow negative for 2013. Additionally, with expected FY2013 capital expenditures of $4.5 to $5 billion there are still large expenses that need to be met. Though as one the largest gold mining companies in the world, we believe that ABX has the resources to produce the cash if there is truly a cash crunch, so at this point we believe there is no true cash crunch threat at ABX.
Production Numbers - ABX did give investors a slight increase in gold production (around 1%) on a sequential basis from 1,797,000 gold ounces to 1,811,000 million ounces for Q2FY13. In terms of copper, ABX also increased production from 127 million pounds to 134 million pounds (around a 5% increase) on a sequential basis. Both copper and gold production seems to remain on track to hit management FY2013 guidance of 7-7.4 million ounces of gold and 500-540 million pounds of copper (copper guidance was raised this quarter).
ABX management was able to slow the rise in true all-in costs to $1295 per gold-equivalent ounce, which is a good sign but we will expect more reduction in costs based on the cost-cutting measures implemented by management. Liquidity remains sufficient, but investors should continue to monitor it because ABX has quite a few large capital expenditures in the next few quarters. Finally, in terms of production the company slightly increased gold and copper production on a sequential basis and this is something investors should monitor considering the cost-cutting initiatives.
For physical gold, GLD, and PHYS investors, ABX report continues to show that gold costs are not significantly dropping which is a bullish sign because mining production is a very important part of the gold supply and demand picture. Until we see gold costs dropping significantly for the major miners, we believe that there will remain a positive tailwind to the gold price.