Gold mines around the world are suddenly unprofitable. But it’s not all due to falling prices. New rules about how expenses are counted are making miners suddenly see red.
Read: 3 myths about gold
The World Gold Council (WGC) brought the rules into effect this summer, after working with many of the largest public gold companies to produce guidelines that would make it easier for investors to compare non- GAAP and non-IFRS cost metrics among producers. Some companies adopted the rules early and the results began showing up in their Q1 2013 statements.
The policies are meant to extend the definition of traditional cash costs, which were intended to reflect per-ounce production economics in the gold industry. It’s evident that basic cash-cost measurements were impacted by flawed accounting-think. For instance, some costs that were capitalized for accounting purposes escaped the calculation of cash costs per ounce. Capitalization is when a company takes a cash outflow and records it on the balance sheet as an asset, instead of reporting it as an expense in the period it was spent. Those assets are then expensed in future years when they’re used to earn revenue.
Corporate management has leeway when considering which cash outflows it chooses to capitalize. The choices can come down to honest differences of opinion, or result from management trying to game the reported numbers more actively. Either way, those differences impact the comparability of results between companies, and make them less useful for investors. For instance, management decides whether underground development, like the use of a tunnel, has an estimated life beyond one year. That type of decision previously impacted period expenses, and therefore, the estimated cash costs of producing gold for that year.
Other major costs that previously escaped scrutiny on a cash-costper- ounce basis include corporate overheads, exploration and stripping. Typically, corporate overheads were not allocated to specific mines, ostensibly so as to not cloud the economics of individual producing assets. Likewise, exploration costs used to be ignored because some of those expenses were not fruitful due to failed projects. Stripping costs were also a major area of difference. In an open pit mine, it was often a question of how much waste rock needed to be removed to access the ore underneath to begin production. These costs were usually capitalized to varying degrees among companies.
Dealing with the issues
The WGC attempted to address these problems by recommending two new measures of production.
01 All-In Sustaining Costs (AISC):
This includes many of the costs described above, as long as they are spent on existing operating sites.
Since management decides which costs are for sustaining activities, the potential remains for the misallocation of costs, and a lack of comparability between companies. However, the new AISC measure still represents a significant step forward for investors in getting a clearer picture of production economics in the industry. For instance, Goldcorp reported second quarter AISC of $1,279 per ounce, compared to cash costs under the old measure of just $646. Given an average realized price per ounce of $1,358, that means Goldcorp’s margin on a per share basis was just $79 per ounce under the new method versus $712 per ounce under the old method (a decline of 89%).
Margins have become so thin at some producers that certain sites are operating at a loss, which has led many miners to attempt to monetize, or shutter, some of their holdings.
02 All-In Costs:
This includes all stripping, exploration, overhead and related costs, whether or not they’re deemed to relate to existing operations or expansion efforts. Barrick Gold, for instance, reported second quarter cash costs of $552 per ounce, AISC of $919 per ounce, and all-in costs of $1,279 per ounce.
The new measures provide ample opportunity for investors to compare metrics. For instance, Goldcorp’s second quarter all-in sustaining costs were as high as Barrick’s allin costs on a per ounce basis. Barrick’s margin on an AISC basis was $492 per ounce in Q2 compared to Goldcorp’s $79 per ounce. That difference really jumps out under the new measures, but would have seemed less significant under the old cash costs metric, which would have produced margins of $859 per ounce and $633 per ounce, respectively.
What it all means
While investors can make many more cross-company comparisons now, they still need to exercise caution in looking at the numbers. In addition to the caveat about potential cost misallocation between sustaining and expansion operations, there are a few other issues to consider.
While the new cost measures are more encompassing, they’re not intended to reflect current cash flows. For instance, the calculation of AISC includes an accountingrelated estimate for future reclamation and remediation costs, which companies normally pay out in cash in the future—often at the end of a mine’s life.
However, no measure is going to capture everything and provide complete transparency and comparability between companies. In fact, the new cost guidelines seem to have a major loophole that could seriously impact their usefulness. Large, one-time write-offs of costs will not be captured in per ounce costs, or be quickly disregarded if they were. The CEO of Randgold Resources, which is not a member of the WGC, has specifically highlighted this deficiency.
Barrick and Goldcorp reported massive asset write-offs of $8.7 billion and $2 billion, respectively, in Q2 2013. This would’ve skewed their reported numbers regardless of what measuring stick they used. So while advisors now have more information to consider, and perhaps a better appreciation of industry economics, they still need to tread with caution.
Dr. Al Rosen, FCA, FCMA, FCPA, CFE, CIP and Mark Rosen, MBA, CFA, CFE run Accountability Research Corp., providing independent equity research to investment advisors across Canada.