Low production costs not mining's holy grail
DISPEL the current gloom: independent thought is that there is still value in selected SA gold stocks.
In a matter of months, the focus of evaluating gold shares has shifted from expressing the market capitalisation in terms of dollars per ounce to one of lowest–cost producer. Needless to mention, many of SA's mines are among the world's most expensive producers.
Yet both valuation methods are vulnerable to interpretation: analysts and investors should be asking themselves what kind of ounce of gold? Is it proven, probable, possible, indicated, Witwatersrand, greenstone, Kalimantan, Kalgoorlie, an ounce of reserve or a total resource?
And what constitutes cost of production - does it include capital expenditure, ancillary costs, financing costs, accounting differences on amortisation? Gengold managing director Tom Dale touched on the issue in last week's quarterly presentation: he pointed out that companies whose mines have "cash" production costs of $200/oz do not always make money. Mines which boast production costs of $150/oz should also be careful: they might be one of the factors pushing down the price of gold if the profit margin is seen as too generous.
RMB Resources, which prepared the competent person's report in listing documents for Randgold Resources in adherence with the London Stock Exchange's stringent rules, says the best way of presenting information to investors is to include a pay–limit/pay–value graph.
"Once you have applied the pay limit, all ounces of gold in the ground anywhere in the world should be equal," says RMB Resources' Andy Clay.
The pay limit or cut–off grade is easily arrived at by dividing the cost of production by the gold revenue. A mine's ore reserve can be represented graphically and looks like a camel's hump: the bulk of the tonnage is of medium grade in grams a ton.
By applying a pay limit, a pay value can be obtained by calculating the average grade of all the payable reserves which lie above the pay limit. If the pay limit moves higher, there will be fewer tons of payable ore reserve. Mines like ERPM where much of the higher grade reserves has already been mined have less flexibility and are more vulnerable to a rising pay limit.
"The beauty of publishing a pay–limit/pay-value curve is that the investor can calculate for himself the ore reserve and market capitalisation per ounce whenever the pay limit changes, rather than relying on management's discretion with respect to such information" says Clay. "The big, blue–chip SA mines still have the greatest ore–reserve flexibility." Most favoured are Vaal Reefs, Western Deeps, Driefontein and Kloof.
Clay suggests a more care would go a long way in avoiding another Bre–X type scandal, whereby samples were systematically salted with gold from another source before being sent for assay–checking to independent parties. "Because the pay-limit/pay-value curve is such a clinical assessment of the asset itself, all mines and exploration companies should be required to publish it. If Bre-X had done so, analysts might have smelt a rat a long time ago."