The Terrible Truth of Gold Mining C

The Terrible Truth of Gold Mining Cost Reporting

Exploration Insights
by Brent Cook
www.explorationinsights.com

Gold production costs as reported by mining companies have always consisted of a somewhat confusing, usually obscure, and often misleading set of metrics. It was my intention this week to make sense of cash costs, total cash costs, and the currently popular “all-in” costs, laying out what it all actually means.

To straighten out some inconsistencies I called Joe Hamilton, a good friend, fellow river rafter, and one of the best mining analysts and economic geologists I know. Joe is now a partner at Primary Capital, a high-quality boutique market dealer that provides M&A advice and finance to exploration and development companies.

After going through the complexities of how gold mining costs are reported a few times, it became obvious I was in over my head. Fortunately, Joe agreed to put his thoughts to paper in. . .

The Rant

The Terrible Truth of Gold Mining Cost Reporting
By Joe Hamilton

Mining companies generally point towards the “Cash Cost” of production to make profitability easy for investors to understand: The difference between cash-costs and commodity spot prices is the “margin” or profit that a company should post to its bank account. Investors are asked to use this as a gauge when comparing investment opportunities between two or more producing companies: lower cash costs obviously provide more cash for shareholders. Nothing could be easier and nothing could be further from the truth! But let’s dig a little deeper into the gold producers. . .

The Cost Numbers

In the last fifteen years we have seen companies report “Cash Costs”, “Total Cash Costs”, “Total Costs” and, now, a move by Goldcorp to report “All-in Cash Costs”. Confusing, to say the least since these ratios and numbers are not signed-off by auditors or accountants and are not even recognized by any Accounting Standards Board anywhere in the world. The companies can use these calculations in any way they wish and frequently the equations for the calculations vary by company. Confounding the entire issue is the concept of “Co-product” accounting or “By-product” accounting – the selection of which has the most fundamental impact on all of the above “Cost measures” but which many companies don’t even bother to specify in their financial statements.

First let’s look at some definitions:

Cash Cost: the cost of production at the mine site, not including head office costs, interest expense, capitalized development or stripping, off-site costs (like smelting or refining costs), taxes or depreciation

Total Cash Costs: Cash Costs plus off-site costs, head office costs, and sometimes interest

Total Costs: Total Cash Costs plus depreciation, interest, and reported taxes (not necessarily paid)

All-in Cash Costs: Cash Costs plus exploration expense, head office costs, and sustaining capital

Before understanding these ratios and numbers, we must look at where a mining company spends its cash and where it gets its cash. The first thing to understand is the difference between a capital item and an expense. For instance, fuel and explosive costs are an expense: the fuel is used this month.

But what about the cost of the storage tank?

It will be used for 10 years and therefore it is not a cash expense, but the cost is averaged over the life of the tank – this is a capital expense and shows up as depreciation over the life of the asset. Our assessment must include both capital and operating costs.

The largest component of cash expenses is usually the mine site costs directly related to production: salaries, fuel, water, grinding media, electricity, reagents, tires, grease and sometimes even sewage disposal. When we total up all of these expenses we get the “Cash Operating Cost”. The auditors look at this number with great scrutiny and it is almost impossible to misstate this number. But this is where the auditors leave our discussion. What about all those other things that consume the cash from a company balance sheet? What about cash consumed today so that I can mine tomorrow? What about stripping costs, underground development in advance of mining, shaft sinking, equipment replacement and new haul roads? Every company must use cash for these items; this is “Sustaining Capital”: money that is spent to merely sustain a production level but is not included by the auditors as an expense. It’s possible to have two mines that produce at $700 per ounce cash cost, but one mine requires $300 per ounce in sustaining capital and the other requires $700 per ounce in sustaining capital. Unfortunately, the investor is only given the Cash Cost number and asked to differentiate between two “identical” gold mines.

While we are at it, shouldn’t we also look at interest costs, debt repayments, head office costs, taxes, and royalties? These are items that are compiled and reported separately by auditors and don’t s