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Sep 2013 - Against AISC

Against the AISC

Since its introduction by the WGC (World Gold Council) the proposed AISC (All in sustaining cash cost) method appears to have spread confusion and damaged share prices such as Silver Lake (SLR.ax) who were one of the first Australian gold companies to adopt it in their March Quarterly 2013.

The problem with cash costs is that they are open to interpretation and many companies adjust the definitions to show themselves in a more favourable "light", if it results in them attracting investment relative to a competitor or gold producing rival.

The current Australian cash cost method is to have C1 operating cash costs (including mining, milling, transport & admin), C2 total cash costs (being C1 plus royalties and less by-product credits), and C3 total costs (being C2 plus D & A [depreciation and amortisation], where D & A is a rough proxy for capex).

The Australian method was based on that suggested by the Gold Institute in 1996 (when gold was ~$400/oz). However, even then there are still basic differences in different countries. The North American golds for example take their by-product credits away from their operating costs, whereas like royalties they are a revenue item (or vary according to the gold price or other commodity prices.

There is supposed to be a limitation on how much revenue comes from say copper relative to gold in a major company's consolidated cash costs, but it seems to be rarely adhered to.

The other issue is royalties. The North American definition excludes royalties that are based on or have an association with profit, as such royalties are classified as a tax and included in total tax. Consequently South African gold company royalties are classified as a tax and not part of cash costs. Some other North American company royalties also apparently fall into this bracket, especially if they are not based directly on revenue.

There is a another variation, in that operating cash costs can be adjusted by stripping and mine inventory adjustments including stockpile movements. these adjustments can be significant, reducing cash costs by ~$200/oz or so in any particular year.

In 2002, the Gold Institute added a further modification allowing stripping to be deferred, such that waste stripping in say an open-cut could be spread over a period over years to smooth out the cost impact.

In 2008, Gold Fields (of South Africa) started their own cash cost method being NCE or notional cash expenditure, being operating costs plus capex, but are considering reporting AISC in 2014.

Some Australian gold companies have stated that they are considering reporting the new standard, while others such as Regis and St Barbara have stated that they are not going to report according to the new standard.

The AISC (no not ASIC, although one gold company did call it that in their June Quarterly) was apparently first proposed by Gold Fields and some of the major North American gold companies as a fairer way of representing the cash costs of gold companies (although it theoretically could be applied to any metal commodity producer).

The current cash cost method is to have C1 operating cash costs (including mining, milling, transport & admin), C2 total cash costs (being C1 plus royalties and less by-product credits), and C3 total costs (being C2 plus D & A [depreciation and amortisation]). However, there have been suggestions that this is not truly representative and total costs could include exploration written off, corporate costs, sustaining capex and possibly even interest payments.

One of the criticisms of the current method is that often the total cash costs have become the quoted cash costs, ie excluding royalties. Which is ok if it is a level playing field of simply government royalties, but they vary by state in Australia, and some companies have other royalties such as some of Alacer's Australian operations and Focus' Laverton operations.

Hence the proposed method, presumably desired by companies in which the additional costs should have a lesser impact, such as the major producers. As for exploration written off, it is very subjective and does not include all exploration undertaken. And sustaining capex is also open to interpretation, as are what should be included in corporate costs.

The AISC is not defined by GAAP so it does not have to be done, and has already become open to interpretation as to what is being included by the major North American gold companies. Gold Fields have their own NEC (notional cash expenditure) method but would not divulge what it includes in response to a question at Diggers 2013, as it is an internal method. Gold Fields may report an additional AISC in 2014.

Some Australian gold companies have already stated that they are not going to report it in the AISC format such as Regis (RRL.ax) and St Barbara (SBM.ax) as they regard the current cash cost (C1) as providing sufficient enough detail, and think the AISC is misleading.

An indication of the misleading perception was given in Figure 1 being Saracen's (SAR.ax) Diggers 2013 presentation showing the AISC at different stages of their Whirling Dervish open-cut. As at June 2013, SAR's AISC for that open-cut is $1150/oz, in one years' time (June 2014) it is $350/oz lower at $800/oz, another year further (June 2015) it is another $200/oz lower at $600/oz.

However, possibly the largest misleading factor in AISC reporting is that it depends on the gold price as it almost represents an ideal scenario. If the gold price falls, then costs are pared back : exploration, capex, corporate, and if necessary even waste development, and by-product credits are affected too. 

An AISC could give an impression that an operation could be uneconomic at a lower gold price, whereas that is not necessarily the case.

So who else wants it, not the fund manager, nor the average private investor, if anything the analyst that wants it, and possibly the larger producers.

So our recommendation is that companies report C1, C2 and C3 in the original format, ideally at least C2 (including royalties and by-product credits). Under which C3 is taken as an approximation for ongoing capex. If a company has been acquired and needs to be amortised then report it as abnormal amortisation. In that format, at least the companies should remain relatively comparable.

If companies do want to provide AISC details then please keep it to page 5 of the quarterly where the analyst can find it, and not confuse the average investor.

Disclosure and Disclaimer : This article has been written by Keith Goode, the Managing Director of Eagle Research Advisory Pty Ltd, (an independent research company) who is a Financial Services Representative with Taylor Collison Ltd.

Figure 1. Saracen's Whirling Dervish Open-cuts' AISC's

  • Written by: Keith Goode
  • Sunday, 01 September 2013