Cost changes raise gold bar

Gold stock investors should now have a much clearer profit and loss picture.

Summary: After strong lobbying from institutional investors, investors will now have a much clearer picture of the full costs being incurred by individual goldminers and be better able to make informed investment decisions. New reporting standards require miners to detail all their production costs, and some miners are barely breaking even.
Key take-out: The World Gold Council has noted that only five of its members using the new reporting system have reported an “all-in sustaining cost” of less than $US1,000 an ounce.
Key beneficiaries: General investors. Category: Commodities.

Did it cost Resolute Mining $811 to produce an ounce of gold last year, or $1,131, or $1,375?

To save anyone guessing, the correct answer is: “all of the above”.

If that sounds unlikely, then it’s time to consider the new gold-cost reporting recommendations of the industry’s peak lobby group, the World Gold Council (WGC).

Before I give a full explanation, take a fresh look at the Resolute example because the three Australian dollar cost numbers show that either (a) the company was strongly profitable at $811/oz, (b) reasonably profitable at $1,131/oz, or (c) was drifting towards marginal profitability at $1,375/oz.

Anyone investing in Resolute, or any other goldminer, is excused for feeling confused as the new rules are applied and the old industry standard, so-called C1 cash cost, is flushed away as the nonsense it always was.

In future, an investor will have a much clearer picture of the full costs being incurred by a goldminer and be better able to make an investment decision based on what’s called “all-in sustaining costs”, or “all-in costs” – though it could be argued that adding two more options for calculating costs is merely muddying already muddy waters.

A clearer picture

In time, and as all goldminers adopt the new reporting standards, it will become clearer and investors will be able to make better-informed decisions.

What’s happened to change a decades-old addiction to C1 cash cost reporting is that institutional investors, led by Evy Hambro, chief executive of the natural resources fund of BlackRock, have been campaigning for mining companies (gold producers in particular) to declare all costs and not hide behind the C1 figure, which masks a multitude of additional costs.

Hambro’s efforts have been successful, though until the new system is fully adopted by goldminers, and eventually forced on miners of other minerals and metals such as iron ore and copper, there will be the issue of triple-layered costs.

Other examples of the confusing picture which exists today are:

  • Northern Star Resources, which last month reported a C1 cash cost of$680/oz, and an all-in sustaining costs of $1,016/oz.
  • Gold Fields, the big South African-based miner with most of its assets in Australia, reported a C1 cash cost for the June quarter of $US857oz (profitable), an all-in sustaining cost of $US1,416/oz (going broke?), and an all-in cost of $US1,572/oz (going broke faster?).

Not all goldminers are yet reporting multiple cost figures, and few investors outside the institutional world really understand what’s changed.

The WGC itself believes that 12 of its 18 members (all of the big goldminers) have started to adopt the new system.

Significantly, only five of the 12 reported an all-in sustaining cost of less than $US1,000/oz.

Three cost tiers

The new system has three tiers of costs, starting with the traditional C1 cash cost, which is essentially just direct site costs of labour, equipment, power and consumables such as fuel and grinding media (metal balls used in crushing ore).

An all-in sustaining cost is then determined by adding 15 additional items, as recommended by the WGC, including:

  1. Royalties and production taxes.
  2. Forward selling and/or hedging gains or losses.
  3. Community costs.
  4. Permitting costs.
  5. Third party smelting, refining and transport costs.
  6. Non-cash remuneration.
  7. Stockpile write-downs.
  8. Operating stripping (open pit) costs.
  9. By-product credits (an add back).
  10. Corporate and general administration.
  11. Reclamation and remediation costs.
  12. Exploration and study costs.
  13. Capital invested in exploration.
  14. Capitalised stripping and underground mine development.
  15. Sustaining capital expenditure.

The chart below from J.P. Morgan estimates the all-in sustaining costs for six goldminers: Regis Resources (RRL), Newcrest Mining (NCM), Alacer Gold (AOG), OceanaGold (OGC), Evolution Mining (EVN), and Perseus Mining (PRU).

It was after adding those costs that other companies such as Resolute, Northern Star and Gold Fields produced significantly different cost-per-ounce numbers than using the C1 method.

Going to the “all-in cost” level (which Gold Fields has done) requires adding another seven layers of cost:

  1. Community costs not related to current operations.
  2. Permitting costs not related to current operations.
  3. Reclamation and remediation not related to current operations.
  4. Non-sustaining exploration and study costs.
  5. Non-sustaining exploration costs.
  6. Non-sustaining stripping and underground mine development
  7. Non-sustaining capital expenditure.

This is how J.P. Morgan estimates the cost numbers to come in, using the same six companies as in chart 1.

Profit or loss?

The effect on some goldminers, as detailed in the Gold Fields example above, is the difference between making a profit or a loss.

Some investment analysts are starting to focus on the new accounting recommendations, with J.P. Morgan concluding in a study published earlier this week that for most Australian gold producers a gold price of $US1,200/oz represents the operating break-even point in 2014.

“In financial year 2015 we expected the break-even point to drop to $US1,100/oz as half the companies benefit from peak investment in 2012-13, through higher production and lower capital expenditure,” J.P. Morgan said.

The investment bank said gold stocks would probably remain volatile for two reasons:

  • Lack of conviction in the next major gold-price move, and
  • Improved understanding of the all-in costs of production for gold.

“Gold equities enter financial 2014 under significantly changed operating conditions, with lower prices eroding margins and lower price expectations prompting a shift towards profitable (production), at the expensive of total production,” the bank said.

Essentially, J.P. Morgan and other financial advisory firms are trying to find a way to answer a critical question from clients: “who is making money?”

Full disclosure required

I go one step further and ask the more fundamental question: “who’s telling the truth about their costs”? Because what’s been disclosed so far is the tip of an iceberg, and until every goldminer adapts the new all-in cost reporting system (sustaining, or otherwise) investors are not being fully informed.

What the WGC is forcing its members to do is reveal all of the hidden costs that goldminers have been able to conceal from the eyes of analysts and investors.

It is now up to every goldminer to disclose precisely what it really costs them to produce an ounce of gold, and for investors to be wary of companies that continue to hide behind the meaningless C1 cash cost.

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