What It Really Costs To Mine Gold: The Barrick Gold Second Quarter Edition

Aug. 8.14 | About: Barrick Gold (ABX)

Summary

Barrick's production numbers continue to decline on both a year-over-year and sequential basis and this is something important for investors to note.

Barrick's true all-in and core non-tax costs are also rising sequentially and the company is merely treading water at $1300 gold.

Management turnover at the company leads us to think the chances of a Newmont and Barrick merger are probably higher than the industry thinks.

Introduction

In our previous complete Q3FY13 cost analysis, we went over a number of the industry's all-in costs to mine an ounce of gold in 2013 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 2013 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.

We're still working on completing and publishing a complete FY2013 and first half 2014 all-in costs for the industry, so if you are interested in receiving it and keeping up-to-date on consider following me (clicking the "Follow" button next to my name) or join our free email list where we send out a weekly email summarizing all the important events in the gold and silver industry, which includes our latest articles and research pieces and all of our all-in pieces as they are published.

In this analysis, we will calculate the true costs of production of Barrick Gold (NYSE:ABX), one of the largest gold producers in the world. Barrick 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.

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 previous 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 Barrick Gold

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 Q2FY14, which results in a copper-to-gold ratio of 419:1. 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

Observations for Investors

Usually we start with an analysis of the true all-in costs for the company, but in Barrick's case, the first thing investors will notice is the clear decline in production that has been occurring over the last two years. Additionally, second quarter production of 1.485 million gold ounces was down around 100,000 ounces from first quarter production of 1.588 million gold ounces. Much of this sequential decline was due to a 50,000 ounces decrease at the company's Goldstrike mine, though the company is forecasting Goldstrike to produce close to 1 million ounces in FY2014, so it seems they expect production to improve over second half of the year.

Barrick is engaged in reevaluating operations and has been actively selling mines over the last year, so a drop in production isn't too surprising. But it is something Barrick investors need to monitor very carefully as mining companies are in a business that constantly requires them to replace reserves - a decline in production is one of the signs that reserves aren't being adequately replaced.

In terms of costs, Barrick's true all-in costs (costs excluding write-downs) were $1453 for Q2FY14, which is well over the current gold price and a rise on a sequential basis as well from Q1FY14's $1407. We do note that the quarter saw a large write-down which can skew this number a bit so we will note the increase in costs but we'll wait until a quarter without significant write-downs to get a more accurate assessment of true all-in costs.

In terms of Barrick's core non-tax costs (costs excluding write-downs and taxes), the company saw costs rise to $1285 per gold-equivalent ounce, which was both a rise on a sequential and year-over-year basis. Since we exclude taxes and write-downs this is a very accurate indicator of the company's cost performance and this is not a positive trend. At a $1285 core, non-tax production cost the company is merely treading water at $1300 gold and offers little return until gold prices rise to higher levels.

On a comparative basis, we've only published the analysis from a few other competitors with Goldcorp (NYSE:GG) registering core non-tax costs of under $1050 per gold-equivalent ounce, Yamana Gold (NYSE:AUY) registering core non-tax costs of under $1200 per gold-equivalent ounce, and Newmont Mining (NYSE:NEM) registering core non-tax costs of under $1150 per gold-equivalent ounce. All of these competitors are producing gold at costs below Barrick, so that's something Barrick needs to improve in future quarters to make this company attractive for investors.

Conclusion for Investors

Barrick's gold production continues to drop due to lower production at existing mines and the sale of existing producing assets, and while we aren't surprised this is certainly a situation for investors to monitor. This drop in production also was probably a contributor to the rising costs all across the board for the company on a sequential and a year-over-year basis, which should be a bit worrisome for investors.

The fact that we're seeing a major restructuring of the company's management is something that should be noted as it could be a positive (management successfully addresses cost and production issues) or it could be a negative as it could mean that management is seeking much better opportunities. Additionally, to throw our hat in the Barrick and Newmont merger talks, this large management turnover leads us to think that the possibility of this mega-merger succeeding is actually much higher than the industry thinks - investors shouldn't be surprised.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.