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

Introduction

In our complete Q2FY13 cost analysis, we went over a number of the industry's all-in costs to mine an ounce of gold in Q2FY13 and 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 Q2FY13 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 Goldcorp (NYSE:GG), one of the largest gold mining companies in the world. GG produces gold, silver, copper, lead, and zinc in countries located strictly in North and South America - an overview of their development projects and mines can be found here on their website.

How to Use Our All-in Costs Analysis with Your Investments

In the previously mentioned article, we gave a thorough overview of the current way that 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.

The best way to use this analysis for individual companies is to compare the different production cost metrics with the company's profits to look for any anomalies (e.g. large net profits but high costs). Also, we provide historic data to allow investors to check out any trends in regards to costs or production totals that may be an early warning to future successes or failures for the company. Ultimately, this analysis is best used as a first step to further investigative work, and that is our purpose with releasing this series.

Explanation of Our Metrics

All Costs per Gold-Equivalent Ounce - These are the costs incurred for every payable gold-equivalent ounce. It includes all company costs to produce gold including write-downs, smelting and refining costs, taxes, etc. 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.

This is the broadest measure of costs, and since it includes write-downs, it is essentially the "accounting cost" of producing gold-equivalent ounces. When there are large write-downs, it can have a significant portion of costs that are the decline in value of existing assets, which is not a cash cost.

Costs Per Gold-Equivalent Ounce Excluding Write-downs and S&R - This is the cost to produce each gold-equivalent ounce when subtracting write-downs and smelting and refining costs, but including everything else. Removing write-downs allows this cost to be a much more relevant cost to what it truly costs to produce each ounce of gold, but since it does not include smelting and refining costs (which is a requirement to be able to sell mined gold) it will underestimate true production costs.

Costs Per Gold-Equivalent Ounce Excluding Write-downs - This is similar to the above-mentioned "Costs per Gold-Equivalent Ounce Excluding Write-downs and S&R" but includes smelting and refining costs. That makes this measure one of the best ways to estimate the true costs to produce each ounce of gold, since it has everything (including taxes) except for write-downs.

The one flaw with this measure is that when removing write-downs it is necessary also to remove the tax benefits associated with those write-downs, which we have to estimate based on the size of the write-down. 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.

Costs per Gold-Equivalent Ounce Excluding Write-downs & Taxes - This measure includes all costs related to gold-equivalent production excluding all write-downs and taxes. Essentially this is the bottom dollar costs of production with an artificial 0% tax rate (obviously unsustainable) which works well because it removes any estimates of taxation due to write-downs or seasonal fluctuations in tax rates which can be significant.

The negative to this particular measure is that since it does not include taxes, it will underestimate the true costs of production. All companies ultimately pay taxes, and by removing them you create a production cost figure that is a bit optimistic and may be misleading to investors.

As investors can see, all the cost approaches above have their pros and cons, but we believe the last two are the most effective in evaluating the true costs of gold production - so we will focus on these approaches even as we list the cost figures for the other two for comparison sake.

True Costs of Production for GG

Let us use this methodology to take a look at GG's results and come up with the true cost figures for each ounce of production. When applying our methodology, we standardized the equivalent ounce conversion to use the average LBMA price for Q3FY13 which results in a silver-to-gold ratio of 62:1, copper-to-gold ratio of 413:1, lead-to-gold ratio of 1397:1, and a zinc-to-gold ratio of 1580:1. 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.

(click to enlarge)

Notes about Goldcorp's Revenues and Costs

In 2013 Goldcorp changed the way that it accounts for its Alumbrera and Pueblo Viejo projects 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 from the calculation (this removes GG's copper production).

Secondly, it means that comparisons with prior quarters are going to be much more difficult because production totals and costs include Alumbrera, while in 2013 these costs and gold production will not be included. So investors shouldn't be surprised to see higher production totals in 2011 and 2012 versus 2013.

Observations for GG Investors

Goldcorp's Q3FY13 true all-in costs (Costs excluding write-downs) rose on a year-over-year basis from $1129 in Q3FY12 to $1169 in Q3FY13 which is a reasonable 4% rise in costs. Sequentially, true all-in costs fell from $1515 in Q2FY13, but the second quarter did include a huge write-down, so we wouldn't read too much into the second quarter's true all-in costs.

In terms of GG's core costs (removing taxes and write-downs), costs have been steadily rising and during the third quarter costs hit $1182.96 per gold-equivalent ounce. This was about a 4% rise on a sequential basis and as investors can see, the core costs of GG are continuing to rise.

Since Goldcorp is the first company we are analyzing in terms of its Q3FY13 results, we do not have any comparisons yet from other companies' third quarter reports. But comparing GG to the second quarter true all-in costs of other companies they compare as follows: Barrick Gold (NYSE:ABX) (costs just under $1300), Yamana Gold (NYSE:AUY) (costs over $1300), Newmont Gold (NYSE:NEM) (costs over $1600), Eldorado Gold (NYSE:EGO) (costs under $1100), Goldfields (NYSE:GFI) (costs over $1500), Allied Nevada Gold (costs over $1300), Alamos Gold (NYSE:AGI) (costs under $1250), Kinross Gold (NYSE:KGC) (costs over $1500), Randgold (NASDAQ:GOLD) (costs over $1000), IAMGOLD (NYSE:IAG) (costs over $1300), and Richmont Gold (NYSEMKT:RIC) (costs over $1300), Silvercrest Mines (NYSE:SVM) (costs over $1000), and Agnico-Eagle (costs over $1400)

We caution investors to do those comparisons with a grain of salt since these comparisons are for different quarters and use different metal conversion rates.

Conclusion

With true all-in costs and core costs below the current gold price, Goldcorp still should rank as one of the lowest cost major miners. Additionally, even though their margins are low, they are still positive and have been consistently profitable despite the fall in the gold price. But investors should also take note of the fact that costs are still on the rise, and that non-gold production is actually forming a larger portion of the company's production totals.

Additionally, those investors predicting a sub-$1000 gold price should note that Goldcorp's core production costs are well above the $1000 price level and should gold fall below that point the company would be losing considerable amounts of money. Though almost anything can happen in terms of short-term price movements (remember the flash-crash?), gold is clearly not sustainable below $1000 for any lengthy period of time because even some of the lowest cost majors wouldn't be able to produce it profitably below that point.

Even after GG cut costs considerably in the third quarter, its core costs are still approaching $1200 per gold-equivalent ounce - so from a production standpoint it doesn't seem gold can be mined profitably much lower from its current price. So gold investors should take this as a positive for their gold investments and be patient - the production costs should provide quite a bit of long-term support for gold at current levels regardless of Fed tapering.

Source: What It Really Costs To Mine Gold: The Goldcorp Third Quarter Edition