Cash cost

Cash costs, in mining, are the costs of production, at site level, per
unit of output.

Cash costs include operational cash costs at site level. This:

includes transport, refining and administration costs and

royalties
excludes non-cash costs such
as depreciation and amortisation
excludes costs not at site level (such as head office costs).

The value of the by-products is deducted from the final cash cost of
the metal. For example, if a copper mine produces gold as a by-
product, then the value of the gold produced will be deducted from
the cash cost of the copper. This is the usual accounting treatment
for by-products in most industries.

Exploration Insights
by Brent Cook
www.explorationinsights.com

Gold production costs as reported by mining companies have always consisted of a somewhat
confusing, usually obscure, and often misleading set of metrics. It was my intention this week to
make sense of cash costs, total cash costs, and the currently popular all-in costs, laying out
what it all actually means.

To straighten out some inconsistencies I called Joe Hamilton, a good friend, fellow river rafter,
and one of the best mining analysts and economic geologists I know. Joe is now a partner
at Primary Capital, a high-quality boutique market dealer that provides M&A advice and finance
to exploration and development companies.

After going through the complexities of how gold mining costs are reported a few times, it
became obvious I was in over my head. Fortunately, Joe agreed to put his thoughts to paper in.
..

The Rant
The Terrible Truth of Gold Mining Cost Reporting
By Joe Hamilton

Mining companies generally point towards the Cash Cost of production to make profitability
easy for investors to understand: The difference between cash-costs and commodity spot prices
is the margin or profit that a company should post to its bank account. Investors are asked to
use this as a gauge when comparing investment opportunities between two or more producing
companies: lower cash costs obviously provide more cash for shareholders. Nothing could be
easier and nothing could be further from the truth! But lets dig a little deeper into the gold
producers. . .

The Cost Numbers

In the last fifteen years we have seen companies report Cash Costs, Total Cash Costs, Total
Costs and, now, a move by Goldcorp to report All-in Cash Costs. Confusing, to say the least
since these ratios and numbers are not signed-off by auditors or accountants and are not even
recognized by any Accounting Standards Board anywhere in the world. The companies can use
these calculations in any way they wish and frequently the equations for the calculations vary by
company. Confounding the entire issue is the concept of Co-product accounting or By-
product accounting the selection of which has the most fundamental impact on all of the
above Cost measures but which many companies dont even bother to specify in their financial
statements.

First lets look at some definitions:

Cash Cost: the cost of production at the mine site, not including head office costs,
interest expense, capitalized development or stripping, off-site costs (like smelting or
refining costs), taxes or depreciation

Total Cash Costs: Cash Costs plus off-site costs, head office costs, and sometimes
interest

Total Costs: Total Cash Costs plus depreciation, interest, and reported taxes (not
necessarily paid)

All-in Cash Costs: Cash Costs plus exploration expense, head office costs, and
sustaining capital

Before understanding these ratios and numbers, we must look at where a mining company
spends its cash and where it gets its cash. The first thing to understand is the difference
between a capital item and an expense. For instance, fuel and explosive costs are an expense:
the fuel is used this month.

But what about the cost of the storage tank?

It will be used for 10 years and therefore it is not a cash expense, but the cost is averaged over
the life of the tank this is a capital expense and shows up as depreciation over the life of the
asset. Our assessment must include both capital and operating costs.

The largest component of cash expenses is usually the mine site costs directly related to
production: salaries, fuel, water, grinding media, electricity, reagents, tires, grease and
sometimes even sewage disposal. When we total up all of these expenses we get the Cash
Operating Cost. The auditors look at this number with great scrutiny and it is almost
impossible to misstate this number. But this is where the auditors leave our discussion. What
about all those other things that consume the cash from a company balance sheet? What about
cash consumed today so that I can mine tomorrow? What about stripping costs, underground
development in advance of mining, shaft sinking, equipment replacement and new haul roads?
Every company must use cash for these items; this is Sustaining Capital: money that is
spent to merely sustain a production level but is not included by the auditors as an expense. Its
possible to have two mines that produce at $700 per ounce cash cost, but one mine requires
$300 per ounce in sustaining capital and the other requires $700 per ounce in sustaining capital.
Unfortunately, the investor is only given the Cash Cost number and asked to differentiate
between two identical gold mines.

While we are at it, shouldnt we also look at interest costs, debt repayments, head office costs,
taxes, and royalties? These are items that are compiled and reported separately by auditors and
dont show up in the Cash Operating Costs. If this is overwhelming, dont worry, its easily
calculated because auditors are not dumb and they give us all the information we need to follow
the cash. We just need to know where to look.

Before we go to the financial statements and apply some Terrible Truth Equations we need to
understand the difference between Co-product and By-Product accounting.

These concepts were developed in base metal mines that always produced multiple metals: gold,
copper, silver, zinc, lead, mercury, antimony to name a few. Auditors stopped using these terms
decades ago. These concepts were never meant to be applied to gold mines and were known to
be flawed, but they were resurrected by some marketing genius. Too bad for investors!

By-product Accounting

In any case, the mine gets paid different amounts for each product and must usually pay
smelting or refining charges too. The difference between co-product and by-product accounting
depends on the contribution to revenue for each metal produced. Generally, to use by-product
accounting a single metal has to contribute at least 80% to revenue the rest of the metals that
contribute 20% to revenue are by-products. If a single metal cannot pass this test, then all the
metals are thought to be co-products. This is important but frequently ignored by companies
when reporting cash costs.

By-product accounting lets companies deduct the revenue that is received from the by-products
from the costs associated with producing all metals at the mine. For instance, a mine may
produce 1000 oz of gold and receive $1.5 million in revenue for gold. It may also produce
10,000 oz of silver and receive $250,000 in revenue. Because the silver revenue is less than
20% of total revenue the Company can use by-product accounting in reporting unit operating
costs. Lets say that the total mine-site operating costs were $1 million to produce the gold and
silver. Under by-product accounting, the Company may deduct the revenue received by selling
the by-products (silver) from the operating costs then divide by the units of gold produced: ($1
million - $250,000)/ 1000 would allow the company to report $750 per ounce cash costs of
production. Hmmm if I look at the cash costs I assume that the Company made $750 per
ounce on 1000 oz of production and I could be safe in assuming that the company booked a
profit of $750,000. But wait a minute they received $1.5 million in revenue and had $1 million
in costs which the auditors will tell you allowed them to book $500,000 in profit. Leprechauns
must have buried another pot of gold! By-product accounting is false, but many companies still
knowingly report these numbers or their evil twin, Cost per gold equivalent ounce.

Co-product Accounting

This gets a little better with co-product accounting, which attempts to assign operating costs to
each metal produced based on its relative contribution to revenue. Lets look at a gold mine that
again produces 1000 oz of gold but 40,000 oz of silver and has operating costs of $1 million.
Revenue increases to $2.5 million ($1.5 million from gold and $1 million from silver) with a
60:40 split between gold and silver. If we were to use by-product accounting we would deduct
the silver revenue from the operating costs and divide by the gold ounces: ($1 million - $1
million)/ 1000 whoa we are producing gold for nothing! Magic - we are probably seeing
leprechauns by this time. Any company that reports negative cash costs per ounce of
production is using by-product accounting. Under the co-product accounting, we need to look at
the contribution to revenue for each product. In this case gold contributes $1.5 million to the
$2.5 million in revenue with the remainder silver (60% gold: 40% silver). The operating costs
are then split on the same basis and divided by the units of production: for gold ($1 million *
60%)/1000 = $600 per ounce AND for silver ($1 million * 40%)/40,000 = $10 per ounce. The
Company should report that it produced 1000 oz of gold at cash costs of $600/oz and 40,000 of
silver at cash costs of $10 per ounce. Now the back calculations work too, with the investor able
to see the correct margins for each commodity. Its a little better and a little more transparent.
But it's a lot different than saying, "We produced 1000 oz at a cash cost of $0"! In addition, we
still haven't considered all those uses of cash like head office costs and interest on our debt.

This brings us to the Financial Statements.

The REAL Cost

Mines don't produce gold or copper or nickel - they produce cash! Really good mines produce
piles of cash. Really old mines or bad mines produce cash but then have to reinvest it just to
keep production steady, with no real cash going onto the balance sheet.

There are two truths in analyzing financial statements: the bank balance and outstanding debt
have been checked by the auditors; and the cash flow statement never lies.

Cash and debt are easy to check, but we can't forget "current debt": that portion that is due in
12 months. If it isn't obvious how a company will repay its current debt then I suggest that the
savvy investor will wait for the upcoming equity issue to invest - and it will come! Long term
debt is easier to understand - a company has at least two years to make the money from
operations. But they need a good cash margin, which is not the one you think they have if you
look only at the reported cash costs. Fortunately we have a calculator, the always honest cash
flow statement, and the Terrible Truth Equations. . .

The first thing to look at on the cash flow statement are the three subheadings: Cash from
Operations, Cash from Financing Activities, and Cash from Investing Activities - there is no other
place for cash to come or go except into one of these three bins. The auditors have signed off on
these numbers and the company can't mess around here. Lets look at Barricks Cash flow
Statement from their Q1 2013 Financials (Fig. 1 below):
(Fig. 1: Barrick cash flow statement)
Cash from Operations

This is all the cash from all the mines. This number has been checked and re-checked by the
auditors - it's real and it cannot be warped, misstated, recalculated or spun in any way. It's
cash! It includes all expenses paid in cash in the period and includes taxes, interest, all office
costs, and all disbursements that are not capital expenditures or debt repayments. The number
next to "Net Cash provided by Operation Activities" is the true cash margin for the Company
from selling its metals: its the total of all cash brought in by the mines after all expenses
(except capital costs and debt repayments as we shall see). If this number is negative then we
have a real problem.

Deduct this number from the total revenue (found on the Consolidated Statements of
Comprehensive Income = $3437 million for the quarter) and you have found the true, no-
nonsense cash cost of production. In Barricks case, the true cash cost of production is $2352
million. This number can't be changed - it's real. What you do with it is up to you, but let's just
look at the absolute number for now. You could calculate the co-product cost of production for
each metal (copper, silver and gold) if you had 30 minutes to kill. For now, lets just divide the
cash cost of production by the number of ounces produced: (Total revenue - cash from
operations)/ oz sold. This is Terrible Truth Equation #1: the true cash cost of production. Since
the company sold 1.747 million ounces in Q1, its cash cost fully loaded to gold was $1,346 per
ounce. This is a rather simple number and should really be adjusted for changes in working
capital (payments to suppliers for materials that were not used immediately but are sitting at
mine sites as inventory like tires, engines, and reagents). It also includes all cash expenses
charged by the company (mine cost, head office costs, interest cost, cash taxes paid, royalties,
pension contributions, lunches, and toilet paper). It is something the companies don't want you
to know and they don't do the math for you. Most gold producers style themselves as a single
commodity Company. Lets go with that and assume that they are mining only gold, and any
other metals are incidental to producing gold - they get paid for the other metals, but there is no
cost attributable and the gold production must bear all the operating cost. Seems fair to me if
you call yourself a gold company instead of a gold-copper or zinc-copper-gold company.

Lets look at some numbers

Agnico Eagle reported 2013 Q1 "Average total cash costs" of $740 per ounce of gold. But if we
follow the cash and apply the Terrible Truth Equation we see that the company really produced
an ounce of gold for $1207. For Barrick, the reported cash cost in Q1 of 2012 was $561 per oz,
but the Terrible Truth is that it was really $1120 per ounce. Goldcorp gets kudos for reporting
both by-product ($565 per oz gold) and co-product ($710/oz) costs for Q1 of this year. The
Terrible Truth is that neither number is correct, and the true cash cost was about $1190/oz.
Newmont does the best job of reporting by correctly using by-product accounting for copper
production, but still shows a reported $1008 per oz for Q1 2013. The Terrible Truth is that the
real number is $1308 per oz. And, these numbers are before any capital or debt repayment, but
they do include exploration cost, those somewhat bloated head office costs, and Board
expenses, interest, and taxes. This is the cost of doing business and it is a number which
companies don't report-- but it is there in the financial statements.
The following table shows some basic numbers from Q1 financials. The last two columns show
the cost of producing an ounce of gold if gold production had to pay all the costs for the
company (100% gold burden) and the cost if we use co-product accounting (and assume that
gold production has a pro-rata share of costs based on its contribution to revenue).

100%
Co-
Cashflow Working Realized Gold
Total Gold Gold product
Q1 2013 from Capital Gold burden
Revenue Revenue Production Gold Cost
Operations Adjustments price Cost per
per ounce
ounce
US$mil US$mil US$mil US$mil oz US/oz US$/oz US$/oz
Barrick $3,437 $2,846 $1,085 -$119 1,747,000 $1,629 $1,414 $571
Goldcorp $1,015 $965 $294 -$45 595,100 $1,622 $1,287 $542
Agnico $420 $375 $146 $12 232,989 $1,611 $1,128 $515
Newmont $2,177 $1,815 $433 -$288 1,113,000 $1,631 $1,826 $540

We admit that this is equally confusing and does not really give companies credit for multi-metal
mines that generate cash and this is, after all, why we mine.

Cash from Investing Activities

This box in the cash flow statement records capital expenditures to build and sustain operations.
It's still cash out the door, but it is sometimes hard to differentiate between new mine
development costs and the capital required at existing operations. But this leads to Terrible
Truth Equation #2: the Burn Rate calculation.

Lets compare two numbers: cash from operations and cash from investing. The first number is
the cash generated from operations after all expenses have been paid. The second number is the
cash consumed in construction activities at both existing and new mines. In Agnicos case, the
company made $146.1 million in Q1 of 2013 from mines and spent $141.5 million in
construction. Hmmm - what happened to the $740 per oz and the implied $871 profit? There
was almost no cash generated! Goldcorp in Q1 2012 brought in $294 million from operations
and spent $533 on construction projects. Fortunately, Goldcorp added $1.5 billion in debt to its
balance sheet in Q1 and ended the quarter with $1.46 billion in cash, otherwise they would be
broke. For Barrick, in Q1 of this year operations brought in $1.1 billion in cash, but they spent
$1.4 billion on construction projects. That's for the first quarter! Barrick took on $2 billion in new
debt in Q1 but repaid $1.2 billion, and paid $200 million in dividends. Give Barrick a nod for
borrowing money to pay its dividend! Newmont made $433 million from operations in Q1 but
spent $507 million in new capital and also paid $211 in dividends. The company borrowed $80
million in new debt to cover the capital expenditures and reduced its cash position to pay the
dividend.

To sum this whole discussion up - "Don't believe everything you are told". The mining companies
continue to spin investors by quoting cash costs but only including partial costs in the
calculation. To give them credit, the tables in the back of 10Q and quarterly MDA filings have
started to show more information, but the tables are becoming impenetrable in the process. The
cash cost numbers seem to be chronically low and some would say possibly misleading.
Thankfully the auditors give you the numbers, and by digging a little deeper the Terrible Truth
can be laid bare. Remember that Colonel William Boyce Thompson, the founder of Newmont,
was asked "Where did you get the name for your Company?". His reply: "Well son, I've got two
mines, one in Montana and one in New York." (I made that up; I don't think Newmont ever had
a mine in Montana! But it summarizes the story nicely.)

014 PRODUCTION AND CASH COST GUIDANCE

All-in
Silver Gold Zinc Lead Cash Cost* Sustaining
(Moz) (koz) (Mlb) (Mlb) US$/t Cash Cost**
US$/oz Ag
Production Guidance 2.0 1.9 22.6 16.6
Cash Cost Guidance 88.3 17.01

* Cash cost per tonne includes all on-site direct and indirect production costs, community relations expenses, concentrate transportation and
corporate management fees. It excludes government royalties and workers participation.

** All-in sustaining cash cost per ounce of silver is based on the guidelines from the World Gold Council.

2014 All-In Sustaining Cash Cost/oz Ag Guidance

2014 All-In Sustaining Cash Cost Guidance
Item
(US$/oz)
Cash cost net of by-product credits 9.36
Government royalty & mining tax 0.34
Worker's participation 0.33
G&A (subsidiary) 1.65
Adjusted operating cash cost 11.68
Corporate G&A 0.00
Sustaining capex 4.76
Brownfields exploration 0.57
All-in sustaining cash cost 17.01