Best of the Week
Most Popular
1.SNP Offers Labour Deadly Death Embrace Alliance, Holding England to Ransom, Destroy UK From Within - Nadeem_Walayat
2.Gold And Silver – Most Widely Used Currency In Western World? Stupidity - Michael_Noonan
3.Election Forecast 2015 - Coalition Economic Recovery vs Labour Collapse - Nadeem_Walayat
4.Election Forecast 2015 - Debates Boost Labour Into Opinion Polls Seats Lead - Nadeem_Walayat
5.Why are Interest Rates So Low? Ben Bernanke, Confused as Ever, Starts His Own Blog to Prove It - Mike_Shedlock
6.Leaders Debate Election 2015 - Natalie Bennett Green Party Convincing Anti-Austerity More Debt Argument - Nadeem_Walayat
7.Labour Economic Collapse vs Coalition Recovery - UK Election Forecast 2015 - Video - Nadeem_Walayat
8.China’s Stock Market Mania; How High can Red-chips Fly? - Gary_Dorsch
9.Gold and Misery, Strange Bedfellows - 31st Mar 15 - Dan_Norcini
10.Ed Miliband Debate Election 2015 Analysis - Labour Spending, Debt and Economic Collapse - Nadeem_Walayat
Last 5 days
Conservatives Start to Pull Away from Labour in Opinion Polls, But is it too Late? Election Forecast 2015 - 27th Apr 15
Gold and Silver - It's ALL about The Big Picture After All - 27th Apr 15
Sheffield School Places Election Crisis - Affluent Schools Demand Increase in Funding - 27th Apr 15
Labour Bribes Voters With Housing Market Stamp Duty Cut and Rent Controls - 27th Apr 15
Stock Market SPX Index at Resistance - 27th Apr 15
Society's Leaders Have Been Digging a Bottomless Economic Pit - 27th Apr 15
Impending Stock Market Top - Trend Forecast Summer 2015 - 26th Apr 15
Desperate Stock Market Bubble Thinking Takes Hold on Wall Street - 26th Apr 15
Stock Market Back into The Bear Suits - 26th Apr 15
One Stock Market Where You Haven't Missed the Bull Market Boom Yet - 26th Apr 15
Migrant Crisis - Europe Has Completely Lost It - 26th Apr 15
What Obama's First-Ever Energy Review Missed - 26th Apr 15
Sheffield Hallam Election Battle 2015, School Places Crisis, Can Nick Clegg Win? - 26th Apr 15
Stocks Bull Market Looks to Resume - 25th Apr 15
Gold And Silver - The U.S. Is A Corporation. Precious Metals Stand In The Way - 25th Apr 15
When the Nuclear Money Option Fails - 25th Apr 15
The War on Cash Special Report - 25th Apr 15
China Economic Slowdown Story - Why “Didi Dache” Is a Phrase You Need to Know - 25th Apr 15
The Trans-Pacific Partnership and the Death of the Republic - 25th Apr 15
Stock Splitting Caused the Stock Market Crash - 25th Apr 15
China Stock Market Parabolic Mania’s Global Risk - 24th Apr 15
What Will Happen to You When the U.S. Dollar Collapses? - 24th Apr 15
Why 2 of U.S. Dollar's Recent Bottoms Have 1 Thing In Common - 24th Apr 15
UK Economy Debt Timebomb Will Explode After Election - 24th Apr 15
Are Gold Stocks the Cheapest Ever? - 24th Apr 15
God, the Stock Market and Pascal's Wager - 24th Apr 15
Greedy Insurers Are in for a Nasty Surprise – Positioning You for Big Profits - 24th Apr 15
Four Things Missing From Obama’s First-Ever Energy Review - 24th Apr 15
How to Grow a Regenerative Medicine Industry - 23rd Apr 15
Stocks and Bonds Seven Year of Negative Returns; Fraudulent Promises - 23rd Apr 15
The Existential Danger To The Euro Is Elections - 23rd Apr 15
Stock Market No Clear Direction As Investors React To Quarterly Earnings Releases - 23rd Apr 15
Is China The Next United States? - 23rd Apr 15
U.S. Oil Glut: How High Can It Go? - 23rd Apr 15
Distorted Financial System Expect Deflation, Inflation And Hyperinflation - 23rd Apr 15
What McDonald’s Corporate Earnings Report Is Really Telling You - 23rd Apr 15
Gold Price Forecast to Become Priceless - 23rd Apr 15
FDIC Plots a Bank Heist Involving YOUR Accounts - 23rd Apr 15
$GOLD Price Year 2007 Again - 23rd Apr 15
Stocks Bubble - The Spread between Stock Prices and GDP is Blowing Out - 23rd Apr 15
Ukraine War - When Did We All Become Murderers? - 23rd Apr 15
Libya Crisis - EU Leaders Are Indicted for Nazi-Style Crimes against Humanity - 22nd Apr 15
Why Alternative Energy Isn’t Taking It on the Chin Despite Low Oil Prices - 22nd Apr 15
Bill Gross - German 10-Year Bunds Short of a Life Time - 22nd Apr 15
How to Profit from the Drop in the Oil Price - 22nd Apr 15
The U.S. Dollar's Move Is More Dangerous than You Think - 22nd Apr 15
Apple Watch Means Apple Will Become Worlds First $1 Trillion Stock - 22nd Apr 15
Half a Stocks Bubble Off Dead Center - 22nd Apr 15
They Said Go to College - Learning to become Debt Slaves - 22nd Apr 15
Best Cash ISA 2015/16, Instant and Fixed Savings Interest Rates, New Flexible Withdrawal / Deposit Rule - 22nd Apr 15
Unsound Banking: Why Most of the World's Banks Are Headed for Collapse - 21st Apr 15
Bitcoin Recent Low Price Volatility Might Be Deceptive - 21st Apr 15
Currency Wars Back As Russia Buys Gold - One Million Ounces in March Alone - 21st Apr 15
The Greece 'Grexit' Issue and the Problem of Free Trade - 21st Apr 15
Why Europe Lets People Drown - 21st Apr 15
Wealth Destruction for the 99.9 Percent - 21st Apr 15
SNP Publish England's Suicide Note as Pollsters Still Forecast Labour-SNP Election Disaster - 21st Apr 15
Characteristics of Extremely Over-Indebted Economies - 21st Apr 15
Trader Education Week -- a Free Event to Help You Learn to Spot Trading Opportunities - 21st Apr 15
Gold & Silver Alert: Silver Stocks’ Signal - 20th Apr 15
Now is the Time to Buy Resource Stocks, Especially Gold Equities - 20th Apr 15
DJ Transportation & Utility Averages Suggest Stocks Bull Market Is Over - 20th Apr 15
Crude Oil Price Bull Market Hope - 20th Apr 15
Stock Market Bears Get Slaughtered Despite Greece Counting Down to Grexit Financial Armageddon - 20th Apr 15
The Rise of the Paper Machines - 20th Apr 15
Gold and Silver Inflection Point - 20th Apr 15
SP500: A Butcher's Stock Market (Chop Chop Chop) - 20th Apr 15
Are Stock Market Bears Slowly Gaining Control? - 20th Apr 15
Sugar Commodity Price Bear Rally - 19th Apr 15
Avoid the Spread of the Stock Market "China Syndrome" - 19th Apr 15
Stock Market Going Nowhere Fast - 19th Apr 15
An Easy Way to Profit From the Two Biggest Trends in the Stock Market - 19th Apr 15
No Scripture Is Divine, Authentic and Beyond the Creation of the Human Brain - 19th Apr 15

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

The War on Cash!

Gold Mining Stocks Profit Margins

Commodities / Gold and Silver Stocks 2013 May 03, 2013 - 05:19 PM GMT

By: Zeal_LLC

Commodities

Gold mining is a very tough business.  Not only is it highly capital-intensive and chock-full of environmental risks, its revenues are entirely at the mercy of a volatile commodity.  It requires some serious mettle to succeed mining gold.

But despite super-high barriers to entry and the countless risk factors that come with mining, the world needs gold, and somebody’s got to produce it.  And believe it or not, a lot of money can be made in this business.


At a high level gold mining is like any other business.  Produce your product at costs less than what you sell it for, and you ought to prosper.  And the wider that spread, the more you prosper.  But unlike most other business, the “what you sell it for” is an uncontrollable variable that can violently move in either direction.

For gold miners the dangling carrot is a rising gold price.  And naturally the best of times ought to occur over the course of a bull market for the metal.  Gold has of course been party to one heck of a bull run over the last decade or so, with its price soaring by a staggering 638% from its 2001 low to 2011 high.  Given this kind of gain, many gold miners have easily chomped that carrot on the way to big gains of their own.

And gold miners, represented by gold stocks, have indeed had quite a run over gold’s secular bull.  As measured by the venerable HUI gold-stock index, the gold stocks have leveraged gold’s gains by greater than two-to-one to their own 2011 highs.

Unfortunately even though gold stocks have sported some of the best gains of the 2000s, they’ve always resided in somewhat of a stealth sector that has captured little mainstream attention.  And typically any mainstream attention they do get is critical, with one of the biggest critiques being their perceived inability to make money.

I’ve long scratched my head at this assertion.  And fortunately it hasn’t really mattered given how much money gold stocks have made us and our newsletter subscribers here at Zeal.  But since I’m an inquisitive guy, I put this assertion to the test.  From a simple ground-floor perspective, is there a way to show that the gold miners at least have the opportunity to turn a profit?  Because if they do, the good ones will do so.

In order to begin to answer this question I like to look at one of the most basic financial metrics, gross margin.  Gross margin is calculated by subtracting cost of goods sold from revenue, and then dividing that tally by revenue.  In its simplest sense, gross margin represents the percent of revenue a miner retains after incurring operating costs.  The higher the margin, the more the miner retains on each dollar of revenue.  Check out the bull-to-date average gross margins for the gold miners!

For gold miners gross margin is quite easy to calculate.  Their cost of goods sold is called cash operating costs, reported on a per-ounce basis.  These cash costs are essentially the cumulative direct input costs of mining an ounce of gold.  Labor, energy, and consumables are typically the largest costs.  And they combine for a dollar amount that is hopefully much less than the price of gold.

For the purposes of this exercise, I use the cash costs of the stocks that comprise the HUI.  These globally-diversified miners are the biggest and best in the world, and account for over a third of the total mined supply.  While certainly not all-encompassing, it is a fair representation of the industry as a whole.

For simplicity’s sake I use the simple average cash costs of the HUI’s primary gold miners all the way back to 2001 (red bars), the first year of gold’s secular bull.  This average cash cost is then scrubbed up against the average daily gold price each year (blue bars).  And with these two numbers I’m able to calculate gross margin (yellow) and the associated spread (white).

First and foremost we see the price of gold consistently rising year after year, a delicious trend for the mining companies.  If they can control their costs, they should be rolling in the dough.  But as you can see, cost control has certainly been a challenge for the miners.

Amazingly back in 2001 the miners were producing their gold at cash operating costs of only $176 per ounce.  Now this seems incredibly low today, but when you consider that the average price of gold that year was only $272, there wasn’t much wiggle room if the miners wanted a shot at making money (most gold miners were not profitable in the late years of gold’s preceding bear and the first few years of the existing bull).

Over the first five years of gold’s bull market, cash costs rose by a staggering 43% to $253.  In any other industry costs rising this sharply would spell disaster, a recipe for going out of business.  For gold miners though, this rise in costs was outpaced by a corresponding 63% rise in the price they could sell their underlying product for.  And this led to a growth in gross margins to the 40%+ range, which is quite impressive.

In 2006 cash costs saw an anomalous year of stability.  But in 2007 they fell back into trend with a sharp ascent higher.  In fact, over the last six years gold miners’ cash operating costs have risen by an annual average of 19%.  2012’s average cash cost of $719 is a crazy 184% higher than 2006.  Put into a different light, 2012’s cash costs are over $100 higher than 2006’s gold price.  And they’re a staggering four-fold what they were at the beginning of the bull.

Again, costs rising at this rate of ascent would have spelled doom for most industries.  Thankfully also beginning in 2006 gold’s price really started to take off.  And over the same period where cash costs rose by 184%, the price of gold rose by 176%.  And led by gold’s big rise in 2006 (+36%, by far the largest bull-to-date annual rise), precedent was set for an increase in average gross margins to the 50%+ range.

Yes, cash costs are rising sharply.  And I discuss the many reasons for this (intentional/unintentional low-grading and huge increases in input costs among the bigger reasons) in a past essay.  But as you can see, gross margins are not being pinched given the offset of rising gold prices.

Overall these robust margins and widening spreads show that the gold miners do in fact have the opportunity to turn a profit.  But even though 2012’s average gross margin of 57% was close to the best we’ve seen in this entire bull market, the vast throngs of haters just don’t seem to care.

As hardened contrarians we’ve grown accustomed to unrighteous gold-stock bashing.  And even though most of the criticism slung our way is emotionally based, fundamentals and performance be damned, there is some criticism that’s perhaps justified.  And it is based on the notion that costs outside of cash operating costs greatly diminish what is represented by conventional gross margins.

Provocatively while conventional cash costs cover the mine-level operating costs of producing an ounce of gold, they don’t actually cover the all-in total costs of producing that same ounce.  Even though cash costs are effective for peer-to-peer comparisons and they do paint a picture of potential profitability, I’ll be the first to admit they are a window-dressed non-GAAP performance measure that doesn’t necessarily tell the entire story.

Though I personally still don’t have a problem using cash operating costs as a legitimate performance measure, this metric’s criticism has prompted some revolutionary changes in the way gold miners will report on their costs in the very near future.  And these changes are the product of an initiative set forth by the members of the World Gold Council that will hopefully silence the critics while also bringing positive exposure to gold stocks.

The members of the WGC are none other than the gold miners themselves, including the majority of those that comprise the HUI.  And I wouldn’t be able to describe this initiative better than Goldcorp CEO Chuck Jeannes does in his company’s 2012 annual report.

“The traditional measure of cash costs is not a realistic view. To produce an ounce of gold, we not only incur operating costs, but we spend sustaining capital at the sites, we spend G&A to keep the lights on, and we spend dollars to explore, to sustain our future. If you put all those together, that’s an all-in sustaining cash cost.  It’s a much more transparent and accurate way of judging the real costs of getting an ounce of gold out of the ground.”

Ultimately all-in sustaining cash costs will give investors a much-more accurate snapshot of the full costs of producing gold from existing operations.  And from what I gather, the WGC is looking to finalize a standard before the end of 2013.

Interestingly even though things are not set in stone, nor has it been universally adopted across the industry, we got a taste of what all-in sustaining cash costs would look like via a handful of miners (including Barrick Gold, Newmont Mining, and Goldcorp) either voluntarily reporting it in 2012 and/or projecting what it will be in 2013.  And among the seven major miners that divulged these figures, the average all-in sustaining cash costs came out to $1046.

Indeed this all-in figure is quite a bit higher than the more conventional cash-operating-cost figure, to the tune of +45%.  And this obviously greatly pinches the margins if these costs are inserted in place of what’s conventionally used.  But considering where the price of gold’s been, is this all-in figure really that scary?  No, not really.

If I used this all-in cash-cost figure with 2012’s average gold price, gross margins would still have come in at 37%.  This is a margin that is still well higher than most other industries.  Wall-Street darling Apple just reported its gross margins at 38% in the first quarter.  And based on the valuations of the gold stocks these days, the miners are showing that these robust margins do in fact translate to positive earnings.

Astonishingly the collective price-to-earnings ratio of the HUI was 11.6x as of the end of April.  Now gold stocks have never been known to be value plays, but this insanely low P/E ratio represents the cheapest these stocks have ever been.  It is well less than half their average P/E ratio over the last half-dozen years, and incredibly nearly half the current collective P/E ratio of the S&P 500 (21.0x).  I never thought these words would come out of my mouth, but gold stocks are currently value plays!

When this highly-scrutinized sector gets its feet held to the fire, it delivers on margin and earnings.  And while it’s certainly not popular to laud the virtues of gold stocks during a time when they are universally loathed, this sector’s strong structural fundamentals sets it up to continue to deliver down the road.

And interestingly miners’ fast-rising costs somewhat support these fundamentals.  As silly as it sounds, higher production costs can actually serve as a backstop for gold’s price.  The closer the gold price gets to costs, the more of a squeeze the miners will see on margin.  And if they’re squeezed enough, production will be cut.

And not only will squeezed margins cut production, there will be less to go around for new-project capex.  If new-project capex is neglected for long enough, new production from next-generation mines will fall behind the depletion rate.  Now if gold demand plummets, this supply pressure wouldn’t be a problem.  But if demand remains high as it is today, it wouldn’t take long for economic forces to bring prices back up to levels that make gold amenable to profitable mining.

Overall it’ll be interesting to see if/how 2013’s gold price action affects mine production.  So far we’re on track to see the first year-over-year decline of the average gold price in this bull market.  And if costs continue to rise, which they are expected to, margins will definitely be thinner.  Will this lead to lower output and subdued pipeline development?

Time will certainly tell.  But given gold’s stout structural fundamentals and the fact that it is wildly oversold, we’re due for a strong back half of 2013 that ought to put gross margins back in line with trend.  And this will do great things for the mining companies and their respective stocks.

That’s right, as crazy as it sounds we’re believers in gold stocks.  It’s no doubt been a brutally tough market for them lately, but their carnage offers one of the best buying opportunities ever seen in this bull.

Join us at Zeal to find out how resolute contrarians are playing these markets.  By subscribing to our acclaimed weekly and/or monthly newsletters you’ll get exclusive market perspective that’s rewarded our subscribers with average annualized realized gains of +33.9% on all our stock trades recommended since 2001.

The bottom line is despite their bad reputation, the gold miners have consistently been able to deliver some of the highest gross margins seen in the markets.  Even though they’ve had trouble controlling their costs, gold’s rising price continues to give them a nice spread to work with.

And the gold miners are trying to get on mainstream investors’ radars by offering up more transparency on the cost side of things with a brand-new metric, all-in sustaining cash costs.  While this performance measure will certainly pinch conventional gross margins, the miners should still have plenty of play.

By Scott Wright

So how can you profit from this information? We publish an acclaimed monthly newsletter, Zeal Intelligence , that details exactly what we are doing in terms of actual stock and options trading based on all the lessons we have learned in our market research as well as provides in-depth market analysis and commentary. Please consider joining us each month at … www.zealllc.com/subscribe.htm

Thoughts, comments, or flames? Fire away at scottq@zealllc.com . Depending on the volume of feedback I may not have time to respond personally, but I will read all messages. Thanks!

Copyright 2000 - 2013 Zeal Research ( www.ZealLLC.com )

Zeal_LLC Archive

© 2005-2015 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Free Report - Financial Markets 2014