Understanding costs that go into gold mining

If you want to analyze a gold mining company, perhaps to buy its stock or perhaps to understand how it relates to the general market, you need to understand the cost factors that go into producing gold.

Mining companies general report two costs: cash costs and total costs. Cash costs are those which take place at the mine site, which can be impacted be the number of ounces removed from the ground and by the costs of supplies to make it all happen.

Some of the input costs in mining are diesel fuel, electricity, explosives, machinery parts and labor. During 2007 and 2008, for example, at a time of high energy costs, inputs throughout the mining industry zoomed. At the same time, however, prices of mined commodities were skyrocketing as well, at a pace faster than the cost of inputs. This was true with gold and silver as well as with other metals.

Requires moving mountains

A significant cost for open-pit gold mines is in the energy it takes haul massive amounts of rock. Each ton of ore might contain only about one-tenth of an ounce of gold. With gold at $900 an ounce, each ton is worth about $90. But it's worth the cost of a $2 million haulage truck because it can carry 300 tons or more in each trip. That makes a load worth a gross of $27,000. (Cut that in half, since a mine might have to move a ton of waste to get to the ton of ore.)

But these huge trucks, with 2,000-gallon fuel tanks, burn tremendous amounts of diesel, amounting to perhaps 25 percent of total cash costs.

Underground mines, such as the deep mines of South Africa, substitute electricity for diesel fuel. This energy must move massive amounts of rock as much as 2 miles to the surface. These ores are considerably richer than the material found in the large open pit, so each ton of underground-mine ore might contain half an ounce of gold and not require an accompanying ton of waste to be removed.

Open-pit mines also need large amounts of explosives. Today's blasting agent is ammonium nitrate (garden-variety fertilizer) mixed with fuel oil. This is manufactured from ammonia, which is a product of natural gas and thus dependent on the price of the feedstock. At the same time oil prices were rising, so were natural gas prices, so mining was squeezed by those additional costs as well. In a declining market for energy products, mining benefits.

Another commodity input cost for open-pit mines is cyanide, which is used to leach the gold (and silver) from the ore.

Labor also is a significant cost, more in underground mines than in open pits, where larger equipment has substituted for additional workers. In many nations of the world, labor is cheaper than in the United States, Canada and Australia, but also is more sensitive to strikes, which hold down production.

During the recent boom in commodity prices, labor has insisted in pay increases that share in the benefits of those prices.

The other cost figure companies talk about is total costs. That takes into account such things as corporate overhead and paying off the cost of developing the mine. Some companies try to do much of the work on a new mine with cash flow, holding down interest expenses, etc. But a typical gold mine today might cost $1 billion to bring on line, so a company will incur debt to do so, paying it off over the life of the operation.

A typical figure in a feasibility study will be the payoff time: If ever bit of operating profit from the mine were put toward paying off the debt, this is how long it would take. Payoff figures require assumptions, such as what the input costs and selling price will be during the payoff period.

Understanding a mining company's finances requires reading down into the management's analysis part of the quarterly and annual reports, all of which are posted on line.

Looking at both types of costs is important in understanding future profitability.  

A Guide To Gold Investing takes a look at issues you might want to consider in deciding whether to add gold to your portfolio and then how to go about doing it.