VANCOUVER – A decade ago gold was worth less than US$300 an ounce and gold producers were desperate to attract investors. One method they developed was to report gold production costs using a minimalist metric, thus 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. That suited producers just fine ten years ago, but as the price of gold climbed more than 500% over the decade the flaws in minimalist cost reporting have started to become clear.
Key among those flaws is that 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 (G-T) 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 $955 because the actual amount the company spends to produce an ounce of gold is much higher than that reported cash cost. A more accurate estimate of production cost has to include much more than just the resources expended – it has to incorporate things like capital expenditures, corporate general and administrative 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 roughly US$1,500 to produce, or US$1,700 if one includes the cost of replacing that ounce in the producer's reserve books. Ralph Aldis, a portfolio manager with US Global, performed a similar analysis and concluded that total production costs average US$1,300 per ounce, 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 license to print money and more like an actual reflection of cost.
It is to foster that exact realization that 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 start reporting more realistic costs and now Goldcorp is leading the way.
"This measure represents a significant change in the way Goldcorp presents cash costs," said Charles Jeannes, Goldcorp's president and CEO, in a conference call. "At present we in the industry use a number of metrics to determine cash costs, whether byproduct, coproduct, 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, general and administrative expenses, 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 actually spend producing an ounce of gold in 2013? The all-in estimate for next year is US$1,000 to US$1,100 per ounce, well above the forecast co-product cash cost of US$700 to US$750 per ounce and far above the expected US$525 to US$575 byproduct cash cost. (Coproduct cash costs do not include revenues from other commodities produced alongside gold, such as silver or copper. Byproduct cash costs do incorporate those revenues, essentially using those 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 coproduct and byproduct cash costs as before.
Jeannes noted 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 is 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 the rising price of gold. The result is equity valuation confusion.
More generally, Jeannes says transparency is more important that promoting a low but incomplete cost metric – and cost transparency will be 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 byproduct cash costs, sustaining capital, corporate general and administrative expenses, and exploration expenses. Jeannes says this team decided it was not appropriate to include new project capital in the costs of today's gold ounces, though he acknowledged there is "healthy debate" over what should and should not be included in the calculation.
A task force within the World Gold Council is examining the issue, in an attempt to create a standard format for the industry. Jeannes said such things "tend to drag on sometimes…so our decision was to go forward on our own this year." He was quick to note that Goldcorp plans to conform to the industry all-in cost standard, once one develops.
Jeannes is certainly keen to see that happen. He concluded his discussion of the new metric by saying: "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."
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