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 Newmont Mining Corporation (NEM), one of the largest gold producers in the world. NEM produces gold and copper in seven countries (United States, Australia, Peru, Indonesia, Ghana, New Zealand, and Mexico) and employs around 40,000 employees and contractors.
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.
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.
Tax Calculations - Since we are removing Derivative Gains/Losses, Foreign Exchange Gains/Losses, and Write-downs we have to estimate the approximate tax benefit (or loss) based on this removal - otherwise we would be removing a gain/loss but not removing the associated benefit/loss associated with the taxes related to that gain. We use a 30% base tax rate for these calculations, but investors can use whatever tax rate they feel most comfortable with.
For example, if a company reports a $100 million dollar write-down, we will remove $100 million from its total costs (removing the effect of the write-down) and then add $30 million to costs (30% * $100 million) to represent the estimated tax benefit that the company gained from this write-down. You must do this if you want to remove any item from the income statement, otherwise you will be using taxes based on a removed income statement item.
True Costs of Production for NEM Q2FY13
Let us now use this methodology to take a look at NEM'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 silver-to-gold ratio of 61.2:1 and 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
Included in NEM's Q2FY13 results was a $2.3 billion dollar 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 NEM's costs for the quarter minus the $2.3 billion write-down; plus smelting and refining costs, plus estimated normalized taxes (previous quarter's taxes of $181 million). The big change here is related to taxes, if we use NEM's quarterly reported taxes (-$325 million) it will skew the true all-in costs to the displayed $1760.54 - this is because at -$325 million the write-down for the quarter should require a greater tax deduction than reported (not sure if NEM is saving the rest of this deduction for future quarters). For example, in the fourth quarter of 2012 Barrick Gold (ABX) reported a $6.2 billion write-down and took a tax deduction of $1.5 billion - so obviously NEM should have a much greater tax deduction than the reported deduction for the quarter. That is why to normalize the all-in costs we simply eliminate the write-down entirely and estimate NEM'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 $1637.74 number is very close to NEM's reported $1548 all-in cost number, which we believe is a little bit looser than our number, but either way the numbers are within 5% of what the company is estimating its all-in costs.
Observations for NEM Investors
The first thing that investors should notice is that NEM's true all-in costs for the quarter were $1638 per gold-equivalent ounce, which is a significant rise on both a year-over-year and sequential comparison. Obviously, this wasn't a particularly good quarter for the company in terms of its true all-in costs, and the company has stated that it is continuing its cost reduction efforts (do they have much choice?) and will be reducing corporate staff by one-third. We would stress though that Q2FY13 was an exceptional quarter and these large write-downs tend to have a significant effect on true all-in costs, so we would want see a more normalized quarter before we really start to worry about the company's costs.
Compared to miners that we've analyzed Newmont's quarter was poor, with many competitors such as Barrick Gold (costs around $1300), Goldcorp (GG) (costs over $1250), Yamana Gold (AUY) (costs over $1300), Allied Nevada Gold (costs over $1300), Alamos Gold (AGI) (costs under $1250), and Richmont Gold (RIC) (costs over $1300) all reporting lower true all-in costs.
Compared to the Q1FY13 numbers (for general comparison purposes only since these are FIRST QUARTER numbers), NEM's competitors such as Goldfields (GFI) (costs over $1500), Randgold (GOLD) (costs just under $1200), Iamgold (IAG) (costs around $1400), Silvercrest Mines (SVLC) (costs below $1100), Kinross Gold (KGC) (costs just under $1400), and Agnico-Eagle (AEM) (costs around $1400).
Corporate Liquidity - Liquidity is very important for investors to monitor in this current gold environment, especially for producers that have higher true all-in costs and negative earnings. NEM reported a balance sheet of around $1248 million of cash and $6.7 billion of long-term debt. Anytime a company has a large amount of debt compared to cash on hand, it is important to understand the debt repayment schedule. For NEM it is the following:
As investors can see, there are large upcoming debt payments in 2014 ($558 million) and 2017 ($1.1 billion). While NEM shouldn't have many problems with the 2014 payment if they do successfully reduce all-in costs, we do think their financial situation will not allow them to make any major acquisitions unless there is a significant rise in the gold price - we just don't believe their financial situation is robust enough to support a large acquisition.
NEM's true all-in costs were $1638 per gold-equivalent ounce, were a show of very poor performance for Q2FY13 for the gold miner. But we should note that the quarter included a $2.3 billion dollar write-down, which tends to skew the numbers a bit - though the company themselves did report their all-in sustaining costs over $1500. So from a cost perspective, Newmont had a pretty poor Q2FY13 - investors should expect management to drop costs significantly in the third quarter because at current gold prices these costs are simply unacceptable.
For physical gold, GLD, and PHYS investors, NEM's report continues to show that gold costs remain quite elevated, 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. In fact, it seems that gold mine supply is already dropping as evidenced in the latest USGS numbers which show that mine supply has dropped every single month in 2013.