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 real costs of production of Yamana Gold (AUY), a mid-tier producer primarily focused in South America with mines in Brazil, Argentina, Mexico, and Chile. The projects in Argentina have a higher element of political risk, which is something investors should note, but this discussion is outside the scope of this article. Nevertheless, investors interested in AUY should keep tabs on the political situation in Argentina because events there may significantly impact the future of AUY's operations in that country.
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
For a detailed explanation of the metrics and each metric's strengths and weaknesses please check out our Q2FY13 full quarterly all-in costs gold report where we discuss them in detail.
All Costs per Gold-Equivalent Ounce - These are the total costs incurred for every payable gold-equivalent ounce, which includes everything. This is the broadest measure of costs, and since it includes write-downs, it is essentially the "accounting cost" of producing gold-equivalent ounces.
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.
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.
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.
True Costs of Production for AUY
Let us use this methodology to take a look at the company'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 around 62:1 and a copper-to-gold ratio of 413:1. 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 Yamana Gold Totals
In 2013 Yamana changed the way that it accounts for its Alumbrera project, which it now accounts as a joint venture equity investment rather than a joint operation. 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.
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.
Observations for AUY Investors
Yamana's Q3FY13 true all-in costs (costs excluding write-downs) decreased significantly on a year-over-year basis from $1,498 in Q3FY12 to $1,151 in Q3FY13, which was also a decrease from the FY2012 average of $1,264. This decrease in costs is the result of management's focus on producing "high-quality" ounces as emphasized in their Q3FY13 quarterly report:
In response to the current volatile gold price environment which puts margins at risk, the company has initiated cost containment and margin reclamation initiatives to focus on quality of ounces produced measured by contribution to cash flows instead of production volume alone. The cost containment and margin reclamation initiatives are consistent with the company's established focus on cash flow generation. The company believes prioritizing financial performance over production is a prudent approach that will deliver value, particularly in periods of volatile and uncertain metal prices.
In terms of AUY's core costs (removing taxes and write-downs), costs have continued to decrease from $1,118 in Q2FY12 to $1,076 in the current quarter. They have also been decreasing on a sequential basis from Q1FY13 core costs of $1,190 to the current $1,075 level. Total production costs haven't fallen from previous quarters, but the decline in gold-equivalent ounce costs seems to be primarily due to a combination of lower taxes and an increase in production of gold, silver, and copper - which have increased throughout 2013.
Compared to AUY's $1,151 gold-equivalent ounce all-in cost; the few other gold companies we've covered in so far in Q3FY13 have reported the following costs: Goldcorp (GG) (costs under $1,200), Barrick Gold (ABX) (costs above $1,350) and Agnico-Eagle (AEM) (costs under $1,150).
But comparing AUY to the second quarter true all-in costs of other companies they compare as follows: Newmont Gold (NEM) (costs over $1,600), Eldorado Gold (EGO) (costs under $1,100), Gold Fields (GFI) (costs over $1,500), Allied Nevada Gold (costs over $1,300), Alamos Gold (AGI) (costs under $1,250), Kinross Gold (KGC) (costs over $1,500), Randgold (GOLD) (costs over $1,000), IAMGOLD (IAG) (costs over $1,300), and Richmont Gold (RIC) (costs over $1,300), and SilverCrest Mines (SVLC) (costs over $1,000).
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.
According to our all-in costs measures, it seems like Yamana Gold management has been consistently improving production costs throughout FY2013 primarily by increasing production, without an equivalent rise in costs. This seems like good news for investors because there cost structure has allowed them to be profitable at even current gold prices. While we don't know if the current lower production costs are at the expense of future gold production (by "high-grading" their projects), we do know that management is improving the profitability of AUY and that's something that should help the company moving forward.
If we see an increase in gold prices and Yamana management can keep costs at current levels, there may be quite a bit of upside as the profit margins can double without a big increase in the gold price.