Gold cash cost per ounce measure has long been the standard for gold miners to give explanations about their business, but for now it's been there a number of gold miners who switch to a more comprehensive manner has been suggested.

For many years, a number of gold companies have gone to lengths, sometimes real lengths, to account for "cash costs per ounce" by applying a combination of devices that can lead to truly extraordinary results.

While details of methodologies are inevitably disclosed only in fine print dozens of pages down, the numbers can create the impression that some gold companies are generating billions of dollars worth of free cash flow: music to the shareholder ear.

Sadly for this music, gold companies are run by humans. A move to a more complete, if not balanced, picture has been signaled by Barrick, the world's biggest gold digger, which for the first time recently adopted the reporting of free cash flow among its key numbers. Free cash flow, computed simply as operating cash flow less capital expenditure, ranks as one of the finest measures of corporate performance, especially when figures for at least three years can be viewed.

It is a number that has been avoided, or certainly neglected, by miners, and was apparently pioneered by diamond miner De Beers, a private company.

An example of the extraordinary reporting of cash costs per ounce of gold can be found in the recent results disclosure from Canada-based Yamana, which recorded "production of 286,682 gold equivalent ounces (GEO) in the fourth quarter [2010] at cash costs of negative USD 34 per GEO".

"GEO" means that Yamana conveniently counts its silver production as gold (is that like kissing your sister?). The negative USD 34/oz cost somehow suggests that a benevolent third party not only paid all of Yamana's cash costs for the period, but also somehow donated Yamana an additional USD 34 for each ounce produced.

This could possibly terrify rookie investors: what does it really mean? To refer to Yamana's full year 2010 numbers, it reported production of 1,047,191 GEOs, "at cash costs" of USD 50/oz. In reality, this was production of 864,768 ounces of gold, and 10.0m ounces of silver (this transmutation may not quite be chrysopoeia, but it does place demands on the philosopher's stone). Yamana also accounted for production of 149m pounds of copper in 2010.

With gold prices well above USD 1,000 an ounce for 2010, the implication of producing just over 1m ounces of "GEO" is, surely, that Yamana produced more than a billion dollars in cash flow; indeed, close to two billions dollars. After all, as Yamana points out, during 2010, its revenues soared 43% to USD 1.7bn.

Yet Yamana's operating cash flow for 2010 was USD 613m (Yamana seemingly picks a cherry here as well, preferring to refer to "cash flows from operating activities (before changes in non-cash working capital items)", which, like "cash costs per ounce", is a non-GAAP measure).

Most (call it all, in round figures) of Yamana's operating cash flow for 2010 was applied to capital expenditure, producing precious little in the way of free cash flow. While any firm would understandably aim to optimize (rather than the old-fashioned "maximise") operating cash flow, the objective of producing maximum free cash flow is not an ends in itself: capital expenditure (both stay-in-business and new mine builds) is, hopefully, one sign of a healthy firm, and equally hopefully, a net-growth firm.

In accounting conventions, revenue and profits (hopefully) dominate the income statement, but capital expenditure, being non-revenue in nature, is not mentioned at all (non-cash derivatives such as depreciation do appear, of course, on the income statement, but are hardly helpful). Capital expenditure appears in all its glory in the cash flow statement, and as the positioning suggests, is highly accurate, being cash, as is most of the revenue shown on the income statement.

Free cash flow gives the investor a dynamic and tangible indicator of overall corporate liquidity. As Barrick puts it: "Free cash flow is a measure that management believes to be a useful indicator of the company's ability to operate without reliance on additional borrowing or usage of existing cash".

Firms rely on fresh capital - when required - from three generally recurring sources, which are inevitably utilised in differing proportions over time: increased debt, retained earnings, and equity issues. A fourth non-recurring, non-operational, category can be identified in disposals; during 2010, Yamana, for instance, raised USD 70m in cash from selling mineral properties. The flip side of this, of course, is in cash laid out for acquisitions.

The bottom line is that for all the reporting acrobatics, Yamana produced precious little free cash flow during 2010: just USD 31m.


USD m 2010 2009 2008 2007 2006
Operating cash flow 613.1 528.0 237.4 242.9 -3.2
Capital expenditure -582.0 -498.8 -496.8 -232.5 -219.3
Free cash flow 31.1 29.2 -259.4 10.4 -222.5
Equity raised 75.5 1.4 272.1 37.9 221.2
Cash on hand 330.5 170.1 167.8 284.9 69.7
Debt -486.6 -529.5 -556.0 -622.5 -18.9
Net debt -156.1 -359.4 -388.2 -337.6 50.8
Dividends -48.3 -29.4 -69.9 -17.2 -2.9
Goldcorp, a global Tier I gold miner, has also for years emphasised strongly its low cash costs per gold ounce mined. Its main published methodology relies on crediting sales from non-gold sales (silver, copper, lead, and zinc) against overall operating costs.

For 2010, thus, operating expenses of USD 1.478bn are offset by sales of the other metals in the amount of USD 862m; along with some other minor deductions, the resulting USD 661m is divided by gold ounces sold of 2,413,800 to produce a cash cost per ounce of gold of USD 274 (the details are on page 44 of Goldcorp's 2010 Management's Discussion & Analysis document).

Goldcorp describes this cost as calculated on a by-product basis. Calculated on a co-product basis for the same period, cash costs were USD 443/oz. The idea of offsetting non-gold metal sales against mine costs demands an interesting logic: costs on a mine are independent, as such, of sales of product. If, say, the gold price rises a lot, it does not necessarily mean that costs rise proportionately; if anything, costs rise anyway.

Another way to calculate Goldcorp's cash costs per ounce of gold is to take the difference between turnover of USD 3.8bn and operating cash flow of USD 1.8bn, and to divide the difference by 2.4m ounces of gold sold. That produces a "cash cost" of USD 829 per ounce of gold, somewhat higher than the numbers published by Goldcorp, viz., the by-product basis at USD 274/oz, and the co-product basis of USD 443/oz.

Given Goldcorp's group revenues of USD 3.8bn for 2010, the impression is possibly that Goldcorp produced billions of dollars in operating cash flow. Happily, this is indeed pretty much the case: 2010's operating cash flow number is reported as USD 1.8bn. This was USD 517m more than for 2009, but does not readily explain the far greater gain of USD 1bn in 2010's group revenues, to USD 3.8bn.

There is roughly half a billion dollars variance between changes in revenue and operating cash flow. Costs and expenses are rising at an impressive rate: while gold production increased modestly to 2.52m ounces in 2010 (from 2.42m in 2009), the income statement shows that Goldcorp's operating expenses during 2010 computed at 1.478bn, compared to USD 1.187bn the year before.

Goldcorp's 2010 year includes the start up of Peñasquito in Mexico, which is going to produce lots of zinc and lead, and also, further down the processing stream, plenty of silver and gold.

The mine marks a further move by Goldcorp away from gold: during 2010, Goldcorp's revenues from silver, copper, zinc and lead were USD 862m, compared to USD 454m in 2009. Measures of free cash flow are metal-blind; most gold miners are increasingly producing other metals as "pure" gold deposits become more difficult to find. As such, the days of relying heavily on promoting "cash costs per ounce of gold" mined may be headed for extinction.

Free cash flow 2010 2009 2008 2007 2006
Operating cash flow 1,787.3 1,270.2 866.0 651.0 763.7
Capital expenditure -1,228.3 -1,348.5 -1,372.0 -871.0 -472.2
Free cash flow 559.0 -78.3 -506.0 -220.0 291.5
Equity raised 95.8 79.1 104.0 70.0 527.5
Cash on hand 556.2 874.6 262.0 511.0 526.3
Debt* -747.1 -735.7 -5.3 -1,065.0 -925.0
Net cash/(debt) -190.9 138.9 256.7 -554.0 -398.7
Dividends -154.4 -131.7 -129.0 -127.0 -79.1
* Including convertibles
Goldcorp's gold output has risen gently over the past four years from 2.3m to 2.5m ounces; over that period, capital expenditure has absorbed USD 4.8bn in cash. Net acquisitions absorbed just over USD 1bn in cash during 2010. Capital expenditure for 2011 is projected by Goldcorp at around USD 1.8bn; gold production is expected to increase to about 2.7m ounces, and to continue rising, to around 4m ounces in 2015.

Whether other gold miners will follow Barrick's lead in including free cash flow among key statistics remains to be seen. While professional gold analysts have tended to follow the "cash costs per ounce" methodology so heavily favoured by any number of gold miners, numbers for "free cash flow" arguably provide a greater balance to corporate results and profiles.

Beyond the metal-blind nature of free cash flow, there is another big reason for its fuller adoption. Like all miners, the gold camp is faced with significant increases in capital costs. Barrick last week indicated that at the Cerro Casale gold-copper project in Chile, a review of additional permitting requirements has led to a "changed operating environment in Chile"; along with Barrick's experience at Pascua-Lama (gold-copper), a review of Cerro Casale's capital cost has been initiated.

Early indications, states Barrick, suggest that the capital cost may be higher by about 20-25% from the previous estimate of USD 4.2bn (100% basis; Barrick owns 75%), which is based on the feasibility study completed in 2009, "and reflects the impact of a stronger Chilean peso, higher labor, commodity and other input costs". At the Pascua-Lama project on the border of Chile and Argentina, Barrick states that pre-production capital is expected to increase by 10-20% to USD 3.3-USD 3.6bn.

While Barrick produced a formidable USD 4.8bn in (adjusted) operating cash flow during 2010, USD 3.3bn of that was absorbed by capital expenditure. That still left free cash flow of USD 1.5bn: most numbers were records.

A decade-long bull market in dollar gold bullion prices has been great for miners, but the yellow metal has not risen in isolation. Capital costs are rising inexorably, along with the costs of skills, to say nothing of increasingly hostile regulatory and fiscal environments.

Free cash flow USD m 2010 2009 2008 2007 2006
Operating cash flow 4,783 2,899 2,254 1,732 2,122
Capital expenditure -3,323 -2,358 -1,776 -1,046 -1,087
Free cash flow 1,460 541 478 686 1,035
Equity raised 127 3,950 74 142 74
Cash on hand 3,968 2,564 1,437 2,207 3,043
Debt -6,692 -6,335 -4,556 -3,148 -4,107
Net debt -2,724 -3,771 -3,119 -941 -1,064
Dividends -436 -369 -349 -261 -191
Revenue 10924 8136 7913 6332 5630
FCF margin 13.4% 6.6% 6.0% 10.8% 18.4%
The million dollar question: how do the various moving factors influence market valuations? Do firms that promote the "cash costs per ounce" mantra enjoy premium ratings?

The first answer is general: "pure gold" stocks have long attracted premium ratings, relative to other mining stocks, so there is no harm to be done by promotion of "low" cash gold production costs, even when the methodology is tortured and demonstrably aimed at showing less than the full picture.

Freeport-McMoRan may operate the world's biggest gold mine, at Grasberg, but the group is seen by investors (and speculators) as a copper-first stock. Its cash flow generation is superior to any single gold stock, and its long-established and mostly big, very big, operations produce significantly more free cash flow than any gold stock.

By contrast, most (but not all) miners seen as gold miners seem to be on treadmills, furiously building new mines, increasingly ones which also produce other metals, and which are more difficult and expensive to build and operate. Copper is the favourite, given the propensity for gold to occur in copper porphyry deposits. Copper has been a spectacular performer for most of this decade.

Over the past three years, Freeport has produced USD 8.3bn in free cash flow. It holds a market value (capitalisation) of USD 49bn, USD 5bn less than gold leader Barrick, which produced a more modest USD 2.5bn in free cash flow over the past three years.

Like Freeport, gold major Newmont operates a number of long-established operations, and produces far more cash flow than Goldcorp, but holds a market value of USD 26.6bn, compared to Goldcorp's USD 39.6bn. Newmont produced 5.4m ounces of gold (and loads of copper) in 2010.

On market valuations, the second answer seems to be that mining stocks that promote and practice "growth" stories attract premium ratings - but only for a certain timeframe. Agnico-Eagle exploded into life as a gold stock during 2004; since then its stock price has risen nearly six fold.

Agnico doubled gold production in 2010 to just under a million ounces. Its mine builds over the past few years have absorbed much cash; overall, the stock has been rewarded with a market value of USD 12bn. Compare that to veteran Gold Fields, which produces around 900,000 ounces a quarter, but which holds a market value of USD 13bn.

As early as 2004, Yamana looked like it would make a go for Tier I status: since then its stock price has risen six fold to over USD 12.00/share, at this juncture. But investors and speculators do not seem keen to buy the stock up to close on USD 20.00/share, a level it made during the early parts of 2008.

Goldcorp exploded into life back in 2001; its stock price has risen more than thirteen fold since then. Over the past decade, Barrick's stock price has risen less than three fold; much the same can be said for Newmont, AngloGold Ashanti, and Gold Fields, the world's top four gold diggers by output, and all well-established. High growth stories, as seen over the past decade in the form of Yamana, Agnico and Goldcorp, among others, reach a point of maturity. The value of stock options consolidates, and then the really hard work begins.

Three year: Three year:
Stock Market Operating Free
price Value cash flow cash flow
USD bn USD m USD m
Agnico-Eagle USD 72.11 12.178 717 -1,361
Goldcorp USD 49.61 39.607 3,924 -218
AngloGold Ashanti USD 49.80 18.984 3,552 366
Barrick USD 53.88 53.802 9,936 2,479
Gold Fields ZAR 124.49 13.026 3,657 532
Kinross USD 15.60 17.687 2,198 438
Newmont USD 54.73 26.630 7,407 2,366
Freeport-McMoRan USD 51.98 48.953 14,004 8,297
Yamana USD 12.94 9.595 1,378 -199
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