Unveiling the hidden costs behind the glitter: Discover the true price of producing an ounce of gold and why it's crucial for investors and mining companies alike.
COST OF PRODUCING GOLD
Ever wonder how much it costs to produce an ounce of gold? Most of us tend to focus on the market price for gold since that is what we hear referenced on a daily basis.
That makes sense. However, investors and owners of gold mining stocks have valid reasons to pay more attention to the production costs of gold in addition to the market price. After all, you have to get the gold out of the ground first before it can be refined and sold.
The emphasis on a lower cost of production for a mining company is similar to any company in any industry - lower costs result in higher profit margins. So, how much does it cost to produce a single ounce of gold?
$1200 PER OUNCE?
A number cited often by industry insiders is $1200 oz. There is considerable debate, though, as to whether that number is accurate.
Some say that the $1200 figure is the result of accounting/reporting practices that may not reflect all of the costs associated with the mining and production process. In other words, $1200 oz. might not be a "realistically" accurate production cost for gold.
The World Gold Council has its own formula for "all-in sustaining costs"...
Guidance Note on Non-GAAP Metrics: All-in Sustaining Costs and All-in Costs
"The Guidance Note on Non-GAAP Metrics - all-in sustaining costs and all-in costs was first issued in 2013. In light of new accounting standards and to support further consistency of application, the World Gold Council published an updated Guidance Note in 2018, which includes incremental enhancements. We have worked closely with our member companies to develop these non-GAAP measures which are intended to provide further transparency into the costs associated with producing gold."
There are problems with quoting a single universal cost for producing gold. Mining costs vary depending on the location of the specific activity: region to region, country to country, etc. The regulatory environment impacts the cost as well.
For example, Thomson Reuters GFMS Gold Mine Economics Service reports that average all-in costs for South Africa were over $1,400 between 2005 and 2013 compared to less than $700 in Peru.
Aside from determining a reliable reference cost, there is another item that affects the entire mining industry and which is the subject of this article - the rising cost of producing gold.
GOLD MINING PRODUCTION COSTS
The cost of producing an ounce of gold continues to rise. Adam Webb, Director of Mine Supply Metals Focus, had this to say...
"Average all-in sustaining costs (AISC) in the gold mining industry increased by 1% q-o-q in Q3’22, reaching a new record high of US$1,289/oz. This was the third consecutive quarter of rising costs, with the average AISC also reaching new record highs in both Q1’22 and Q2’22 before being surpassed in the latest quarter. The average gold AISC is now 14% higher than it was in the same quarter last year and 32% higher than in Q3’20."
Here is what may be the most important point of emphasis from the above quote: "The average gold AISC is now 14% higher than it was in the same quarter last year and 32% higher than in Q3’20."
Miners cannot pass on the rising costs of production by raising the price of their end product or service, as happens for most businesses. Their selling price is set by the gold market.
We need to know what has happened to gold prices since the third quarter of 2020 and how that compares to the 32% increase in gold production costs since then.
The price of gold peaked in the third quarter (August) of 2020 at $2060 oz. The reporting
quarter in the article, third quarter of 2022, saw the gold price in declining mode with the price averaging in the $1600s, four hundred dollars less than its peak two years earlier.
While miners absorbed the continually higher prices of production, their selling price continued to decline.
SHRINKING PROFIT MARGINS FOR MINERS
During most of 2020, the AISC was under $1000 oz. Measuring that cost against the market price for gold of more than $2000 oz. results in a suggested gross profit margin of $1000 oz.
Unfortunately, for the miners, their costs of production continued to rise, while their final selling price continued to decline. That potential margin of $1000 oz. was closer to $350 oz. ($1650 gold price - $1300 AISC = $350). That is a shrinkage of sixty-seven percent!
Even with the latest upward thrust in the gold price back towards its 2020 peak level, the suggested gross profit margin is still lower by almost one-third.
OTHER FACTORS AND CONCLUSION
It should be pointed out (and has been by others) that a rising percentage of gold production takes place at costs higher than the prevailing market price.
Just by itself, that is sufficient reason to question the reliability of an 'average' $1289 AISC.
There is another reason that gold stock investors should be wary of expectations and predictions for their mining shares...
With the cost of gold production rising, any corresponding decline in the gold price could find the mines operating at net losses.
Kelsey Williams