Weighing the Cost of Gold

Gold production costs have been silently increasing for years, hidden behind inconsistent reporting metrics that emphasized short-term impact. When gold prices fell sharply to below $1,200 per ounce in June 2013 and then remained depressed until recent months, the actual long-term costs of gold mining were forced into the spotlight. The industry embarked on aggressive cost cutting and slashed exploration expenditure in many instances, but the gold price also emphasized that the industry had no single up-to-date, consistent standard of cost measurement that captured the true cost of mining an ounce of gold. That month, the World Gold Council issued guidance on non-Generally Accepted Accounting Principles (GAAP) metrics that sought to more fully reflect the economics of gold mining, providing a more comprehensive, long-term view of the costs to produce an ounce of gold. Sophisticated investors have long since recognized that existing cash cost measures frequently fail to capture the full cost, leading gold miners to fail to capture sufficient margin in the gold price bull-run as cost inflation and weakening average grades merged. Management teams rightly point to the true cost of mining when addressing wider stakeholders, such as governments and trade unions, but it is little wonder they latched on to the cash cost measure pushed so heavily by the industry itself. Unions and governments generally perceived super profits within the industry based on the short term “cash cost” measure. As a result, the industry continues to wrestle with these stakeholders seeking a share of the gold price — a price that remains robust by historical standards and significantly above those reported cash costs in most instances. This contributes to the continuing wage disputes in the South African gold industry, and is reflected in the moves by various African governments to amend mining codes. Opponents of traditional cash cost measures argue that they not only provide an incomplete picture of mining costs over the years, but also suffer from inconsistency across a variety of measures and formats. The Natural Resources practice at BDO in the United Kingdom conducted an analysis of cash cost disclosures by leading gold producers from 2008 to 2012, and found that 70 percent disclosed a total cash cost measure. However, each measure involved a wide range of Key Performance Indicators (KPIs), including total production cost, gold-equivalent ounce production cost, by-product cash cost and operating cash cost, among others. Only half of the companies using total cash cost stated that they followed the Gold Institute guidance, a predecessor to the World Gold Council’s more recent Guidance Note. Some gold producers included reconciliations to demonstrate how they arrived at non-GAAP cost measures, but comparisons between companies are difficult for a number of reasons:
  • Reporting methods vary widely around issues such as gold sold or produced, by-product credit for copper and other metals, and non-routine items
  • Treatments of inventory write downs and non-cash remuneration differ across companies
  • Varying approaches to recognizing royalties within cash cost measures
The World Gold Council Guidance Note hopes to change the traditionally narrow cash cost measures and establish more uniformity and transparency in reporting, moving the industry toward all-in-sustaining costs and all-in-costs calculations. The World Gold Council has stated, “The all-in sustaining costs is an extension of existing cash cost metrics and incorporates costs related to sustaining production. The all-in costs include additional costs, which reflect the varying costs of producing gold over the life-cycle of a mine.” The all-in sustaining cost effectively extends the historic cash cost measure to incorporate wider corporate costs, additional non-cash items such as share-based remuneration, rehabilitation charges and the capital expenditure and exploration required to sustain, rather than materially increase, existing production levels. All-in costs takes this a step further, incorporating expansion capital expenditure and exploration costs to give a full life-cycle cost for the business as a whole. Gold producers are increasingly starting to adopt these measures, but the new metrics leave a number of issues open to interpretation that may cause lingering inconsistencies, including:
  • “Sustaining capital expenditure” is defined as all capital expenditures except those involving “major projects,” which materially increase production; the term “major” is highly subjective
  • The development of new operations are classified as non-sustaining costs, but there is no guidance about the point at which costs incurred on such mines move out of “development” and into “sustaining capital expenditure”
  • A significant portion of exploration costs are related to sustaining existing production over the long term, but some may argue that most of their exploration costs are tied to expanding the reserve base and therefore excluded from the measure
  • Companies are “encouraged” to reconcile previous metrics with the new guidance, but there is no prescribed format for these reconciliations
Regardless of the concerns with the new measures and their implementation, the World Gold Council’s guidance is a step in the right direction and will contribute to improved industry transparency. Investors need analysis based on longer time horizons to better evaluate underlying trends and costs. The key to success will be cooperation within the industry to support the new guidelines, and these moves will go a long way to rebuild trust in cost reporting. This guest post has been written by Ryan Ferguson, Audit Director with the Natural Resources practice at BDO, LLP in the United Kingdom. He can be reached at ryan.ferguson@bdo.co.uk.

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