The Crazy World !

• Don’t take a description of costs for granted as they vary from miner to miner.
  
• Mining costs aren’t an accounting metric, but most miners should follow the World Gold Council’s guidelines.
  
• Apart from disclosure metrics, there is a metric that doesn’t deceive.
  

As gold is getting more interesting as a buying opportunity, it’s important to identify the miners that offer the highest reward for the lowest risk.

In mining, companies with the lowest risk are the ones that produce with the lowest costs. Costs are pretty fixed while revenues depend on market prices. Now, if we take a look at Barrick Gold’s (NYSE: ABX) last earning report, it included statements like these:

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“Gold production in the third quarter was 1.38 million ounces, at a cost of sales applicable to gold of $766 per ounce, and all-in sustaining costs of $704 per ounce.”


and


“Cost of sales applicable to gold is expected to be $800-$850 per ounce for the full year. We have reduced our 2016 all-in sustaining cost3 guidance to $740-$775 per ounce, marking three consecutive quarters of improved full-year cost.”

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Given that the price of gold is around $1,190 we could imagine gold miners are enjoying huge profits, but this is far from reality. In this article, we discuss how are mining costs disclosed in order to give a good tool for finding low risk miners.


When you dig into miners’ statements, you’ll find the following cost descriptions: cash cost, total cash cost, total costs, and all-in cash costs. None of the above are audited, they don’t appear in any accounting standard, and they differ by miner, so they have to be taken with a grain of salt.

In 2013, the World Gold Council issued a guidance note on how to disclose all-in costs. This is a non-GAAP metric, but widely recognized as the methodology to use. Before we discuss all-in costs in more detail, let’s first discuss the other cost descriptions.



Cash costs include the costs of production at site level per unit of output. Thus, the regular costs for operating the mining process.

As each mine is different, so are the cash costs. Some miners include smelting or refining costs and deduct by-product benefits while others don’t. In any case, cash costs don’t include head-office costs, taxes, exploration, depreciation, depletion expenses, and financing.

By adding off-site costs, head office costs, and sometimes interest, we arrive to total cash costs according to one source. A second source states that by adding sustaining capital—the capital required to keep on the lights at the mine—to the cash costs, we get total cash costs.

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Total cash costs methodology

Therefore, if a company discloses cash costs, total cash costs, or total costs, the only comparative methodology to use is to analyze the disclosure methodologies in detail and create one methodology for your due diligence. After a while, you’ll know exactly which company does what and adjust your data accordingly.In order to solve the ambiguities around mining costs, the World Gold Council published a guidance note on all-in sustaining costs and all-in costs for miners to use.



All-in sustaining costs are really an extension of the vague cash costs discussed above. Sub-total costs (figure 2) would be the cash costs and all-in sustaining costs, the total cash costs and all-in costs would be the total cost.

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Guidance note on all-in sustaining and all-in costs

Costs not included in the guidance are income tax, working capital, financing charges, M&A costs, and impairments.

Now, with such a straight forward guidance, you would expect a clear and easily comparable situation in the mining sector. The figure below demonstrates how costs still remain a vague concept.

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Barrick Gold’s costs and guidance

ABX has three cost variables: cost of sales, all-in sustaining costs, and cash costs. As described above, to properly understand what is going on, you have to dig into their explanation of what’s what.

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Barrick Gold’s costs explanation

he biggest expense excluded from ABX’s cost calculations is depreciation. This isn’t a cash cost, but skews the perception a novice investor can have on the company.

One metric that is audited and can’t skew your perception is cash flow.


In the end, all that counts is how much cash has been made for investors. Going back to ABX, it had revenues of $2,297 million in Q3 2016, produced 1.38 million ounces in Q3 2016, and sold gold at an average price of $1,333. Some of the revenues come from copper, but to make thing easier we’re going to assume it is all from gold.

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Barrick Gold’s cash flow statement

From cash flow, we see that cash provided by operations is $951 million, or 41% of revenue. This implies that operating cost per ounce of gold is 59% of revenue, or 59% of $1,333 which results in $786 per ounce, which is very close to the cost of sales applicable to gold (figure 3).

When we deduct investing activities ($193 million) from the net cash flow, we get $758 million or 32% of revenue bringing costs to $893 per ounce. By adding sales proceeds to the figure, we get to a cost of $946 per ounce, which is already much higher than any reported cost measure by ABX.

Going from cash flow to net income makes things even worse. As net income attributable to ABX’s shareholders is $175 million or 7.6% of revenue, net profit per sold ounce is $101, creating real production costs of $1,232 per ounce for ABX.


The above is an example of how you can quickly go from the all-in sustaining costs of $704 per ounce over the cost of sales of $766 per ounce, to $1,232 per ounce when depreciation, taxes, and all other costs are added in.

I understand there will always be lots of debate on this, but this is the nature of assessing mining costs. At the end, what counts is how much of the margins increase your equity or end up in your bank account as dividends.

The conclusion is simple, find the best metric for your investing style and for what is important to you, check to see how the company adheres to that metric and adjust appropriately.

source: investiv