A decade ago gold was worth less than US$300 per oz., and gold producers were desperate to attract investors. One method they developed was to report gold-production costs using a minimalist metric, making their potential for profit seem larger.
Thus was born the concept of the “cash cost” to produce an ounce of gold. This metric has become the industry standard for reporting gold production costs, but it tells an incomplete story. By only including the costs of the resources required to produce an ounce of gold — labour, power, supplies and the like — it ignores a raft of other expenses involved in operating a mine.
The result is an artificially low number. This suited producers just fine 10 years ago, but with the price of gold climbing more than 500% over the decade, the flaws in minimalist cost-reporting are becoming clear.
The dramatic difference between this low cash-cost metric and today’s high gold price makes it seem that gold producers should be making money hand over fist. If Goldcorp only has to spend US$645 to produce each ounce of gold and gold is selling for more than US$1,600 an ounce, the major should be rolling in revenues, right?
Wrong. Goldcorp is doing just fine, but its profit per ounce of gold is nowhere close to US$955, because the actual amount the company spends to produce an ounce of gold is much higher than its reported cash cost. An accurate estimate of production cost would include more than just the resources expended — it would have to incorporate things like capital expenditures, corporate G&A expenses, exploration expenses and sustaining capital.
Adding those expenses to the tab brings Goldcorp’s actual gold production cost to more like US$865 — and that’s still on the low side. A CIBC assessment concluded that most gold ounces cost US$1,500 to produce, or US$1,700, including the cost of replacing the ounce in the producer’s reserve books. Ralph Aldis, a portfolio manager with U.S. Global, performed a similar analysis and concluded that total production costs average US$1,300 per oz., slightly lower than then CIBC result, but still far above the $500 per oz. cash costs commonly reported.
Suddenly a gold price of US$1,650 seems less like a licence to print money and more like an actual reflection of cost.
To foster this realization, Goldcorp is adding a new metric to its financial reporting: the all-in sustaining cash cost. For several years the World Gold Council has been urging producers to report more realistic costs, and now Goldcorp is leading the way.
“This measure represents a significant change in the way Goldcorp presents cash costs,” Goldcorp president and CEO Charles Jeannes said in a conference call. “At present, we in the industry use a number of metrics to determine cash costs, whether by-product, co-product, gold equivalent and the like, and most will agree that none of these are perfect, and none provide a full accounting of just what it costs to produce an ounce of gold. By including costs such as sustaining capital, G&A and exploration expenses, we believe a clearer picture is presented of the true costs in our business.”
So just how much does Goldcorp expect to spend producing an ounce of gold in 2013? The all-in estimate is US$1,000 to US$1,100 per oz., well above the forecast co-product cash cost of US$700 to US$750 per oz., and far above the expected US$525 to US$575 by-product cash cost. (Co-product cash costs do not include revenues from other commodities produced alongside gold, such as silver or copper. But by-product cash costs incorporate these revenues, using the other products as credits towards the cost of producing gold.)
The all-in metric will be an addition to the company’s financial statements — Goldcorp will continue to report co-product and by-product cash costs, enabling investors to compare the different metrics and compare future cost predictions with past results.
Jeannes notes that some might question the decision to report an all-in cost, given that it is so much higher than the standard cash cost and therefore less appealing to investors and partners.
“The answer lies in the need for our industry to face head-on the issue of gold equity valuations versus the price of gold,” he said. When analysts or investors use cash costs to assess a company’s value, the artificially low number skews the calculations, especially in relation to rising gold prices. The result is equity-valuation confusion.
More generally, Jeannes says transparency is more important than promoting a low but incomplete cost metric — and cost transparency is more valuable for the company in the long run.
“We believe each ounce of gold we produce must generate an appropriate return on investment, and illustrating the full picture on those costs enables a transparent and more productive conversation to take place with our mine and project teams as they consider new investments, as well as with our investors and importantly other stakeholders, who in my view have often considered policy actions based on a skewed understanding of our sector’s profitability,” Jeannes said.
The company’s all-in cost includes by-product cash costs, sustaining capital, corporate G&A expenses, and exploration expenses. Jeannes’ team decided it wasn’t appropriate to include new project capital in the costs of today’s gold ounces, though he acknowledged there is “healthy debate” over what should be included in the calculation.
A task force within the World Gold Council attempting to create a standard format for the industry. Jeannes says such things “tend to drag on sometimes . . . so our decision was to go forward on our own this year,” and that Goldcorp plans to conform to the industry’s all-in cost standard, once one is developed. Jeannes is keen to see that happen: “I call on our peers in the industry — as well as you, our investors and analysts — to work towards the adoption of an industry-wide, all-in cost standard.”
The gold sector can only benefit by reporting production costs in a way that is more accurate and useful. How this metric should be calculated is debatable, but it is far better to have that debate than to continue pretending that gold is easy or inexpensive to produce.
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