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There�s an interesting
interview done by Geoff Candy over on mineweb. com. In the interview Geoff asks Gold
Fields CEO, Nick Holland �What went wrong with the gold industry?� Holland�s
reply is very informative.
�I think if you go back to the late
�90s when gold was at a low of about $250 per ounce the industry at that time
was really hanging on by its teeth and in order to do so was high grading and
if you look at the average grades companies were mining it exceeded the
reserve grade and that was never sustainable.
The other thing is
exploration was cut back quite a lot and there�s typically a timeframe of
anything up to ten years or even longer between initial grassroots
exploration and discovery and construction of a new mine. We�re seeing the
impact of some of that coming through the lower grades, grades have been
declining steadily over the last ten to 20 years, against that backdrop we�ve
seen cost inflation on a per ton basis - if you take out the grade effect �
of anything between 10% to 15% per annum. That compounded means you would
double your costs in five years, four to five years you�d double your costs.
If you�ve got a grade decline on top of that you can see the overall impact
on your total cost of producing an ounce."
A cash-cost standard was
introduced by the Gold Institute in the 1990s and adopted by the gold mining
industry. Cash operating costs only include:
- Direct mining costs
- Third-party smelting
- Refining
and transport costs, minus byproduct credits
Using minimal cash cost
accounting was once beneficial to a hurting industry, but over the last few
years this minimalist reporting metric has hurt investors and gold miners in
two significant ways:
- Cash
cost reporting masks massive production cost escalation and almost flat
profit margins despite gold�s price rise
- The
gold mining sector was targeted for new and higher taxes and royalties
based on expected but unrealized profits
Using a different, more
encompassing method of reporting costs would give investors a better, more
accurate picture of the entire industry�s profitability.
All-in metrics would
count expenses such as:
- Sustaining capital
- General
and administrative expenses (G&A)
- Exploration expenses
- Royalties
- other than profit-based royalties
- Production taxes
- Total
production costs which add in depreciation, amortization and reclamation
and mine closure costs
An �all-in� cost measure
would highlight the more investable, higher grade gold equities with better
sustainable margins able to withstand the ups and downs of a cyclical
industry with volatile prices.
A complete breakdown of
costs, an �all-in� cost figure, courtesy of CIBC, shows cash operating costs
pegged at $700 an ounce. Sustaining capital, construction capital, discovery
costs and overhead at $600. Add in $200 for taxes and you get US$1500.00 as
the replacement cost for an ounce of gold.
Scotiabank calculates
�full cost reporting� (all-in cost plus development capital), at US$1,458 per
gold oz for the companies it covers.
�Complete cost
reporting� is full cost plus corporate taxes, it�s forecast for 2013 at
an average of US$1,690 per oz. gold.
Dundee Capital Markets
reported that the average all-in cash cost in Dundee�s silver equities
coverage universe was $22.96 per ounce during the second quarter. Dundee�s
all-in cash cost calculation includes: site operating costs, exploration,
corporate G&A, interest costs, royalties, taxes and sustaining capital.
Using the all-in figure
provides a more accurate and definitive picture of actual mining cost and
profit.
Below is a graph and a
snippet from an excellent interview Joachim Berlenbach did with The Gold Report�
 
Joachim Berlenbach: �This
graph includes all of the costs that make up a company's free cash flow:
operating cash costs, sustaining capital expense (capex), expansion capex,
exploration and finance costs, plus a bit of general and administration
expense (G&A).
Total costs are
sitting at $1,600/oz for the 13 biggest companies, which has been our
universe for the last 13 years. Over the last two to three years, we have
seen total costs rise an average of 15�17%. At a gold price of $1,600/oz, the
industry does not produce a single Dollar of free cash flow. If we take a
cost inflation of only 10%/year, we will need a gold price over $2,000/oz to
maintain production��
World Gold
Council
For a long time the World
Gold Council (WGC - the industry backed group that promotes gold), has been
pushing gold miners to introduce a consistent all-in costs measure - a task
force has been examining the issue in an attempt to create a standardized
reporting format for the industry.
�It is expected that
these new metrics, the �all-in sustaining cost� and
the �all-in cost� will be helpful to investors, governments, local
communities and other stakeholders in understanding the economics of gold
mining. The �all-in sustaining costs� is an extension of existing �cash cost�
metrics and incorporate costs related to sustaining production. The �all-in
costs� includes additional costs which reflect the varying costs of producing
gold over the life-cycle of a mine. It is up to individual companies to
determine how they report to the market and to decide whether their
stakeholders will find these new metrics of value in understanding their
businesses; it is expected that, since many companies report on a calendar
year basis, they may choose to use these metrics from 1 January 2014.� World Gold Council
Gold production
will drop
The underlying financial
health of any company depends on ongoing profitability - sustainable margins.
In a quest to improve
their bottom line gold mining companies are:
- Cutting jobs
- Deferring capital expenditure programs
- Cutting exploration
- Shutting
down or selling uneconomic mines � ie Barrick plans to sell, close or
trim production at 12 of its 27 mines where costs are higher than $1,000
per ounce
- Cutting dividends
- High grading
�In the coming
months, we will see a huge effort by the industry to reduce costs. To become
profitable again, the industry has to increase cash flow. To do this, a
company could write off or stop capital projects already committed to.
Instead of investing, it will try to preserve its free cash flow�
The industry also
could go back into high-grading the ore bodies. High-grading means picking
out the high-grade parts of an ore deposit to reduce costs in the short term.
I saw this happen when I worked in the South African gold industry at the end
of the 1990s. The gold price was below the breakeven price. Companies stopped
exploration and started high-grading.
In the short term,
high-grading might result in more profitable mines and better cash flow. But
in the longer term, it means that we cannot mine enough gold. Gold production
has not increased over the last 10 years, despite the rising gold price; it
remains at 2,600 tons, or 80 million ounces (80 Moz), per year. If companies
do not invest in new mines, gold production will drop drastically.� Joachim Berlenbach, The Gold
Report
Conclusion
Gold miners (and their
investors) stark reality is that the capital costs of construction (Capex)
and the daily cost of operations (Opex) have escalated significantly.
An investor into the gold
mining space has to look at the space from a bottom up perspective � on a
mine-by-mine, company-by-company basis. Questions need to be asked regarding
reporting metrics to find the outstanding gems that still exist in the space.
Leveraging into a few
good junior gold and silver companies owning the better precious metal
projects should be on all our radar screens. I�ve got a few on my screen, but
then I�m ahead of the herd. Are you AOTH?
If not, you should be.
Richard is the owner of Aheadoftheherd.com and invests in the junior
resource/bio-tech sectors. His articles have been published on over 400
websites, including:
WallStreetJournal, USAToday, NationalPost,
Lewrockwell, MontrealGazette,
VancouverSun, CBSnews, HuffingtonPost, Londonthenews, Wealthwire, CalgaryHerald,
Forbes, Dallasnews, SGTreport,
Vantagewire, Indiatimes,
ninemsn, ibtimes, businessweek.com, moneytalks and the Association of Mining Analysts.
If you're interested in learning more about the junior resource and
bio-med sectors, and quality individual company�s within these sectors,
please come and visit us at www.aheadoftheherd.com
If you are interested in advertising on Richard�s site please contact
him for more information, rick@aheadoftheherd.com
***
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