All That Glitters: The Top Three Gold Producers

In case you've been in a cave without WiFi or Wall Street Journal delivery since the summer of 2005, gold has been on a tear for three years, and the last six months in particular. Yes, it has pulled back from flirting with the $1,000-per-ounce mark, but there is no denying that the last few years have been a lot of fun for gold watchers.

If you listen to the industry buzz, more signs point up than down for the near future. Let's take a quick look.

 

Gold 100 oz (GC, COMEX) Monthly Price Chart

 

The spot price for gold closed at $875/ounce on May 6, 2008. Gold futures on the same date for the May contract were running a little above that, with a dip into backwardation for the June contract. Contracts for July, August, October and December are sitting in contango.

 

NYMEX Futures 5/6/08 Session close
May 2008	881.4
June 2008	877.2
July 2008	879.3
Aug 2008	882.3
Oct 2008	885.8
Dec 2008	890.2

 

With that in mind, it should be a great time to be a miner, right? Well, maybe not as champagne-popping as you'd think.

You see, mining companies are affected by much more than just the price of gold. Rising energy costs, exploration, environmental laws, currency fluctuations, management decisions - they all end up reflected in a company's bottom line. So while gold has been rising astronomically, the cost of mining has been rising too. Have the mining companies been able to take advantage of the spike in gold prices? Or have all of the other factors eaten away at their profits?

Gold Producers Considered

The top three gold producers in the world are Newmont Mining Corp (NYSE: NEM), AngloGold Ashanti (NYSE: AU) and Barrick Gold Corporation (NYSE: ABX). These are all large, multimine, multiproduct, multicountry operations. Let's take a look at how they've been doing. We'll go alphabetically, because who you consider top dog is a source of constant speculation, data mining and mud wrestling.

 

 

 

 

 

 

 

All of these graphs look pretty similar on the outset - they all have the company's average received price of gold going up as gold's spot price goes up. But the interesting thing to note is that total cash costs for both AngloGold Ashanti and Barrick have risen steadily since 2005. Newmont Mining is the only one of the three that actually shows a decrease in total cash costs for the first quarter of 2008.

Total cash cost is the yardstick of choice for looking at mining companies. It's a per-ounce measurement that has nothing to do with the company's actual legal, generally accepted accounting principle numbers. Instead, mining companies use it to monitor their real mining operation performance.

Because it is a non-GAAP measure, each company can use it in a slightly different way (is the founder's Ferrari a cash cost? Probably not, but good luck extracting that from the numbers). Still, it is a measurement (however imperfect and uneven) that is commonly quoted by analysts when talking about company performance and profitability.

 

Newmont Mining Corp	2005-2006	2006-2007	2007-Q1 2008
Change in Average gold spot price	36.04%	15.07%	33.09%
Change in average rec'd gold price	35.93%	17.34%	33.86%
Change in total cash costs	28.94%	33.99%	-2.46%

 

Newmont Mining Corp is also the only company that reports its average received price of gold to be virtually the same as the spot price. In reality, Newmont received (on average) $7 less than spot in 2005, $10 less in 2006, but was paid $2 more than spot in 2007 and $8 more than spot in the first quarter of 2008. Confused? Remember these are averages, and anything can happen when you start pulling numbers together. Suffice it to say that Newmont has managed to get the most for their gold by holding costs down and simultaneously taking advantage of gold's high price.

The price differential between total cash costs and average price received by Newmont has gone from $202 per ounce in 2005 to $291 in 2006 and 2007. The first quarter of 2008 saw that gap widen to a whopping $537 per ounce.

Newmont wasn't alone in making the jump. Barrick was also able to profit in the first quarter by taking advantage of gold's January moon shot, in addition to slowing down the growth in costs.

 

Barrick	2005-2006	2006-2007	2007-Q1 2008
Change in average gold spot price	36.04%	15.07%	33.09%
Change in average rec'd gold price	23.69%	14.00%	49.43%
Change in total cash costs	26.34%	23.67%	12.29%

 

But AngloGold Ashanti seemed to have missed the boat, with total cash costs rising higher and faster than each previous year while the received gold price not keeping pace.

 

AngloGold Ashanti	2005-2006	2006-2007	2007-Q1 2008
Change in average gold spot price	36.04%	15.07%	33.09%
Change in average rec'd gold price	31.44%	9.01%	20.03%
Change in total cash costs	9.61%	15.91%	20.45%

 

As our good friends at iAfrica.com reported yesterday, AngloGold had lower production in the first quarter of 2008 compared with the end of 2007 due to power shortages in South Africa. Five days off-line is a lot of time in this business, and the power shortages and rationing continue to affect production, not only with higher costs, but also with a lower supply of electricity, which means lower productivity. Eskom Holding Limited, South Africa's state-owned utility company, states that energy shortages may last seven years. Other forecasts put that time scale at 2012, when new power plants come online. Add to that an unfavorable hedge position, which meant that AngloGold received only $755 per ounce instead of the average of $925 for the period, and the picture begins to get clearer and less appealing.

By contrast, Newmont was able to get rid of its gold hedge book in June of 2007, as it proudly announces in its 2007 annual report. Looking at the chart, it looked like they were doing a pretty good job of getting as close to spot as anyone throughout the period.

The Long View

Like corn, iron or most commodities, gold relies heavily on energy inputs. Mining is energy-intensive. Electrical power, diesel, even people power (which requires food, and thus wages) - all are used in great quantities. Just like ethanol plants building their own cogeneration facilities in Iowa, some gold mines are ideally situated close to hydroelectric facilities which supply all the electrical power needed to power the lights, pumps and equipment in the mine. Others are remote, relying on long miles of electrical lines or huge diesel generators for power.

Mines are also situated in countries that are looking to improve their economies. Just as in the oil industry, countries are re-examining how they handle their mineral wealth, and permits for new exploration or expansion can be held up as governments figure out what's in it for them. While we don't see the kind of crazy shenanigans of Uncle Hugo in Venezuela, gold companies aren't immune to political pressures of their own.

And then there's the oil-field problem. The bottom line is, there's not a lot of new gold being found. Here's Barrick's CEO Greg Wilkins' view of gold at Barrick's annual meeting.

Wilkins honed in on what he referred to [as] a "new paradigm for gold." He noted that -despite the fact gold prices have soared and record levels have been spent on gold exploration - "virtually no new discoveries" have been made.

Meanwhile, global mine production has dropped 6.4% in six years. The situation is being exacerbated by South African gold mining safety issues and the shortages of electrical power, according to Wilkins.

The former top four gold producers - South Africa, the US, Australia and Canada - now only produce 35% of total global gold mine supply, he added. As Munk would later reiterate, where the international gold industry is going is more of a challenging picture than a rosy one. "This is as tough a business as it gets, and it's not getting any easier," Munk declared.¹

In other words, it's possible that all of the efficiencies that can be wrung out of the gold mining business already have been, and the cost of getting the yellow stuff out of the ground are only going one way - up. This means that a pick-and-shovel approach to gold carries with it the very real risk of an immediate profit squeeze if prices retreat. On the face of it, at $400 an ounce, every one of these companies goes belly up.

Of course, as in investor, what you really care about is how this hits your portfolio. If you're a pure gold bug, you're buying bullion, futures or a pure-gold ETF. But what if you're a stock market investor? It's been a rocky ride:

 

 

Gold has consistently performed better than gold miners as a whole (represented here by the Van Eck Gold Miners ETF, GDX). This would seem to back up the core premise here - that miners are not facing pure windfalls with high prices of gold, and that production costs can stifle what would seem like pure gravy. When we look at the big three, the story is consistent, if slightly more nuanced.

 

 

There are really two big stories here. The first is AngloGold. Anglo failed to capture the upside in terms of realized prices, and simultaneously faced some of the worst increases in production costs in the business. They also took the hit from the African power crisis full in the face.

On the other hand, we have the dance between Newmont and Barrick. While both companies are at the top of the gold game in terms of efficiency and price hedging, they face the very real day-to-day challenges of being a public company. Barrick, for its part, has been hitting it out of the park, making several acquisitions in the last year that met with market approval and hitting all its financial marks. Newmont, on the other hand, had a billion-dollar write down in their fourth quarter and some pretty complicated deck-chair shuffling on the accounting statements. My favorite quote:

"Noting the variety of special charges, the fourth-quarter results were ‘largely immaterial, quite frankly,' HSBC Global Research analyst Victor Flores said. ‘You could drive yourself nuts trying to figure out what they actually earned.'"

Adding further uncertainty, there is perpetual speculation that Barrick will eventually buy Newmont, although those rumors have been a lot quieter this year than last. The bottom line is this: Ultimately, how well miners get the ore out of the ground, and how good they are at locking in the right prices are the two things that drive the stock price.

Everything else is ultimately noise. Of course, that noise can send you into the poorhouse if you're not careful.

 

¹Wilkins recently had to take a leave of absence due to illness; Chairman Peter Munk is assuming CEO responsibilities.

 

Links

AngloGold widen loss iafrica.com, May 6, 2008

Metals Surge as Rationing Cuts Power at Biggest Mines Bloomberg.com, May 5, 2008

Barrick Bullish on gold prices; ‘Virtually no new discoveries' will keep demand tight North Bay Nugget, May 7, 2008

Newmont Results Shine on Soaring Gold Prices Wall Street Journal, April 24, 2008

Gold plummets on dollar strength CNNMoney.com, March 18, 2008

Profit Rises at Barrick, Goldcorp; Write-Down Weighs on Newmont Wall Street Journal, February 22, 2008