The full absurdity of cash cost reporting for gold miners is really coming to the fore with the latest batch of quarterly and half yearly reports from the world’s leading gold mining companies.
On a cash costs basis virtually all the world’s significant gold miners would appear to be profitable – most highly so, yet as we foreshadowed ahead of them on Mineweb the latest quarterly and half yearly profit figures coming out of the gold mining sector are, virtually without exception, dire.
One might have been forgiven from asking in the past why reported earnings have invariably worked out as being way below the optimistic estimates suggested by cash cost reporting, and this quarter the figures are really making the point that at current gold prices even the best of the world’s gold miners are either making losses, or are only at best marginally profitable.
That’s a sobering fact for gold stock investors who may well have misunderstood the actual profit implications of the cash cost figures promulgated by most mining companies in their quarterly and annual reports in the past.
There is a case for reporting cash costs though, but only in context. They do signify how an individual mine can fare in a given gold price environment.
What they do not take into account is the myriad of other costs, royalties, taxes and overheads a mining company can face in trying to sustain production across a group of operations – and this is why many miners are beginning to report what are now described as all-in sustaining costs – which in many cases are actually around double the cash cost figures or even more. This has been put forward as a sensible way of reporting by the World Gold Council. And by and large the major miners at least are falling into line on this.
What this new metric will also do will surely help to focus the minds of senior executives in guiding companies forward in terms of cost controls.
The biggest difference between cash costs and reality is usually the capital costs incurred as necessary to keep the company operating at the production levels of the past, or to expand – something institutional investors have always been keen to promote among the companies in which they hold stock.
Gold mines are depletng assets. They have finite lives, and often as mining progresses ore grades fall as well leading to diminishing metal output unless capital is spent on plant expansions, exploration or the building of completely new mines to come on stream as production falls away at the older mines.
Because this expenditure is usually capitalised in the accounts, it doesn’t necessarily impact on reported mine operating profits, but it still does have a significant impact on a company’s overall earnings and its ability to pay dividends, either because of loan repayments and interest, or through financing capital out of earnings.
Indeed it has been noted that some gold majors had been forced to borrow money, or sell off properties, in order to have sufficient cash in the bank to pay their regular dividends.
Former Mineweb colleague, Barry Sergeant, campaigned strongly in these pages with regard to mining companies publishing some form of all-in costs figures (free cash flow as he called it), which made him decidedly unpopular with some of the mining companies at the time, although some others, notably South Africa’s Gold Fields were already reporting in this manner.
In truth Sergeant noted that, at that time, for most of the big gold miners his ‘free cash flow’ figures were indeed negative, often substantially so, although most were actually reporting book net profits and paying dividends accordingly.
To an extent this works out fine in a rising gold price scenario, but when the price falls, the reporting anomalies become much more apparent.
While the gold price was rising gold mining company executives became rather lax in their controls – this is hardly unique in the annals of the mining industry.
The same happened with copper miners in the 1960s and 70s when previously high metal prices fell dramatically.
Like the current gold price falls this led to some smaller companies going out of business altogether and much consolidation in the industry. The biggest copper names of the time, Asarco, Kennecott, Phelps Dodge to name but three, were all eventually swallowed up – by Grupo Mexico, Rio Tinto and Freeport McMoran respectively – yet arguably, at the time those three copper miners were among the world’s largest mining companies of any kind.
Could the same fate perhaps fall on some of the top global gold miners as the fallout runs its course? Some are looking very vulnerable indeed.
Whatever occurs though on the corporate front the fallout will mean the eventual development of a much leaner and meaner gold mining sector, although this will indeed take time for the kinds of capital and operating costs controls to filter through to the bottom line.
This flight from profligacy will likely continue for a few years, but these controls could well fall away again if the gold price increases significantly and real profits start to multiply.
What goes around comes around.
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