Gold myths, copper truths

Does Barrick, the world’s biggest gold digger, need to be defensive about its CAD 7.3bn offer for Canada- and Australia-listed Equinox, a copper miner in Zambia and Saudi Arabia? The record shows that “pure gold” players among big listed gold stocks are becoming increasingly scarce. During the first quarter of this year, Barrick itself produced 75 million pounds of copper.

Just as telling is that Barrick produced that copper at total cash costs of USD 1.25/lb; few bona fide copper miners anywhere are unable to make cash profits at this level. Copper is one of the world’s most lucrative minerals, trading recently close to USD 4.50/lb, and currently around USD 4.22/lb. Gold miners could only wish for these kind of margins.For the first quarter of 2011, Phoenix, AZ.-based Freeport-McMoRan reported operating cash flows of USD 2.4bn; for the same period, Barrick managed a more modest USD 1.4bn. Freeport-McMoRan is the world’s biggest publicly traded copper miner, but also operates the world’s biggest gold mine. Depending on the observer’s viewpoint, Grasberg, Indonesia, is a copper mine, first and foremost. Freeport-McMoRan has avoided the trap of fashioning itself as metal-specific.

“Pure gold” miners have long enjoyed a premium rating in stock markets, but ratings do not necessarily put food on the table, at least, not to the extent that copper can. This is showing clearly in Freeport-McMoRan’s market value (capitalisation), which recently pushed up to nearly USD 55bn. Impressive as the number is, the real take away in this context is that Freeport-McMoRan’s market value surpassed Barrick’s, which is currently around USD 51bn.

Copper is sexy, supported by long term underlying real-economy demand and growth. Another reason why gold miners are moving increasingly out of gold is because “pure gold” deposits are increasingly difficult to locate. Copper porphyry deposits sometimes contain useful amounts of gold, and tend to remain in operation for longer than the typical “pure gold” mine. And bulk mining methods can be used with impunity, to great cost-advantage.

Another compelling reason for gold diggers to muscle up on cash flow by favouring copper is that new mines are becoming impressively expensive. Earlier this year Barrick indicated that at the Cerro Casale copper-gold project, a review of additional permitting requirements has led to a “changed operating environment in Chile”; along with Barrick’s experience at the in-build Pascua-Lama mine (gold-copper), a review of Cerro Casale’s capital cost has been initiated.

Early indications, said Barrick, suggested 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 was 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 straddling Chile and Argentina, Barrick states that pre-production capital is expected to increase by 10-20% to USD 3.3-USD 3.6bn.

There may be potential targets, such as Equinox, where buying in the market, even including a premium, is kinder to capital returns.

More broadly, there are increasingly clear signals of a change in attitude by gold miners. For years, some gold miners that also produce other metals have conveniently used “credits” from sales of other metals to massage down the “cash costs” for producing gold. This may look pretty on the page, but does nothing to produce tangible extra cash flow. Barrick recently became the first gold digger to formally start producing numbers for “free cash flow” – simply, operating cash flow less capital expenditure.

The measure is metal-blind, and offers a useful indicator of a firm’s overall liquidity. A low number for free cash flow is not necessarily indicative of underperformance; it may correspond with a period of heavy capital expenditure which, in theory at least, promises future benefits for stakeholders. Free cash flow numbers, especially when viewed over longer periods of time, indicate whether a firm may need to resort to additional outside funding, such as available from debt and equity markets.

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