􀀗 The use of ‘cash costs’ and ‘total costs’
is subject to interpretation and,
moreover, is not representative of the
industry’s cost structure
􀀗 We introduce the concept of ‘aggregate
costs,’ which is more representative of
the sector’s per ounce profitability
􀀗 There is a strong correlation between
aggregate costs and the gold price,
although not enough evidence to imply
causality
For many years, the gold mining industry has relied on the
concept of “total cash costs” as a measure of mine site
break-even profitability and “total costs” as a measure of the
capital-adjusted cost of producing gold at both the project
and corporate levels. Both of these metrics, however, are
deeply flawed, in our view. Both measures ignore many of
the other costs required to run a gold mining business –
among them corporate overheads and exploration – which
are often dismissed as “discretionary.” The use of cost
accounting concepts, such as depreciation, to measure mine
profitability is also flawed, we believe, as depreciation can
be reduced by writing assets down or by allocating purchase
costs to goodwill.
The industry’s “total cash costs” averaged approximately
USD444/oz in 2008, implying that the sector had operating
margins of about 49%. “Total costs” averaged cUSD578/oz,
which suggests misleadingly a highly profitable industry, as
the gold price averaged USD872/oz last year. The “notional”
cost figure of USD660/oz is, in our view, slightly more
representative of the industry’s cost structure, and could be
used as an indicator of pretax margins.
Our definition of “aggregate costs,” which we view as the
fully loaded cost of production, totaled USD849/oz last year
and includes total cash costs, capital expenditures,
exploration, corporate administration, and the cost of
finance. This figure has shown a strong correlation with the
gold price over the past nine years. We believe, however,
that if there is any causality, it is costs that respond to
changes in the price, and not vice versa.