A company where copper is as good as gold

New Gold Inc. is, as its name suggests, a gold miner. But its another metal, copper, that plays a large role at the company perhaps larger than a casual investor might suspect.

How so? New Golds New Afton mine, west of Kamloops, B.C., produces twice as much copper than gold, in dollar terms. That allows New Gold, quite legitimately, to report extraordinarily low company-wide mining costs, much lower than at its properties where gold dominates.

The role of copper at New Gold offers a window into how byproduct accounting, as its called, can impact miners financial statements. And it raises an important point for New Golds shareholders: To evaluate the companys prospects going forward, its essential to keep an eye not only on the bullion that gives the company its name, but on the lesser metal that provides New Gold much of its cost advantage.

To be clear: The copper factor is not hidden. Investors can plainly see the effects by carefully reviewing the miners reports.

New Gold released its preliminary 2014 numbers earlier this month, with full results to come Feb. 20. New Gold reported all-in sustaining costs (AISC), a number designed to capture the true long-term cost of mining, of $845 (U.S.) per gold ounce in the fourth quarter.

When broken out per property, there was a wide variance: Its Mesquite property in Arizona reported AISC of $1,090, while its Australian Peak Mines and its Mexican property Cerro San Pedro reported AISC of $1,231 and $1,447, respectively, both above the price of gold in the quarter. (See table for more detail.)

New Afton, however, reported AISC of negative $560 in the quarter, sharply decreasing the companys average number. That overall cost figure is something the company emphasizes: Its Feb. 4 news release said the 2014 results meant it was solidifying its low-cost position in the mining industry.

How can a company report negative costs at a mine? The answer lies in the industrys preferred method of byproduct accounting. When a mine produces more than one metal, the company chooses which one is the predominant product. Then, it expresses the mines costs in terms of ounces (or pounds) of that primary product.

The revenue from all other salable products at that mine, then, is used as an offset against the costs. It looks at things through the lens of the primary product youre producing and remeasuring everything else in line with that products units, says Jorge Beristain, a mining analyst for Deutsche Bank. (He does not cover New Gold.)

Mines where the byproduct makes up a significant amount of production by revenue or even a majority can drive the costs into negative numbers. Thats the case at New Afton, where the 25,300 ounces of gold mined in the fourth quarter generated about $30-million in revenue, using New Golds average realized price of $1,188 per ounce. The 20.4 million pounds of copper generated about $60-million in revenue, assuming New Golds average realized price of $2.92 per pound.

To be clear, New Gold is not the only miner to benefit from this accounting. Goldcorp, for example, reported AISC of $595 in 2013 and negative $395 in 2012 at its Alumbrera mine in Argentina because it mined nearly as many pounds of copper as ounces of gold.

There are other choices for multiple-product mines that may be more suitable in other circumstances, but may also add to the confusion. Mr. Beristain notes Kinross Gold uses gold-equivalent accounting to translate silver sales into what the metal would fetch as ounces of gold.

And co-product accounting simply splits costs of a mine proportionate to the revenue from each mineral. Its best used when a single mine has a wide variety of products, none representing a majority.

In a June, 2014, report, analysts at Dundee Securities Ltd. examined the industrys costs using co-product accounting to make it easier to compare the companies. They found that co-product gold AISC numbers were $1,348 per ounce, $374 higher than AISC numbers calculated using byproduct accounting. By categorizing revenues from non-gold production as a cost credit, the gold production cost profile of a company is distorted.

Randall Oliphant, New Golds executive chairman, says his company is an industry leader in disclosure, noting that the Dundee report of last June recognizes New Gold and Goldcorp for being the only two of 18 companies the firm covered to report an AISC number that is closest to the definition created by the World Gold Council. (Mr. Oliphant, a chartered accountant, is chairman of the council.)

Mr. Oliphant says it makes sense for companies that present themselves as a miner of one product, primarily, to present sales of other products as a credit. And he presents a simplified example of the concept: If you go buy a case of beer and youre going to get 10 cents a bottle back, do you say the beer costs the total amount you paid when you went into the store, or do you look at a net cost after you return the bottles?

What this means for New Gold, however, is that its near-term future depends nearly as much on copper prices as gold, no matter what it has chosen as its primary product. And with copper down 20 per cent since last summer, thats a sobering prospect for New Gold shareholders.

Analyst John Bridges at JPMorgan says the companys cash flow is needed to build its Rainy River mine in Northwestern Ontario, making it more sensitive to swings in metals prices. New Golds shares underperformed the NYSE Arca Gold Bugs Index of miners from Jan. 5 to Feb. 4 by 30 per cent in part because copper prices fell by 11 per cent during that period, he says.

Mr. Bridges believes New Gold can spend $700-million at Rainy River over the next two years and still be liquid as long as copper stays above $2.25 a pound and gold stays above $1,100 per ounce. At those prices, he says, the company would have virtually zero liquidity by the end of 2016, assuming no asset sales. (The most traded copper and gold futures contracts closed Friday at $2.605 a pound and $1,227.10 an ounce, respectively.)

It means the metal that makes New Gold a low-cost producer could also provide the company and its investors with headaches.

Copper and gold

New Gold emphasizes its low-cost position in the gold mining industry but a big deal of the credit goes to copper produced at its New Afton mine west of Kamloops, B.C. New Afton reports negative all-in sustaining costs because of byproduct accounting, a method that takes revenue gained from copper sales and credits it against the mines costs. While the company has a low overall AISC, two of its four mines report cost figures higher than current gold prices.

	All-in sustaining cost (US$ per ounce)
	4th qtr 2014	4th qtr 2013	Fiscal yr 2014	Fiscal yr 2013
New Afton	-560	12	-650	-133
Mesquite	1,090	988	1,266	1,108
Peak Mines	1,231	1,106	1,025	1,331
Cerro San Pedro	1,447	1,076	1,354	766
All-in sustaining costs	845	883	779	899

Read the article A company where copper is as good as gold (the article is posted in Brightspace).

Required:

In your own words, briefly state what is meant in the article by By-product accounting and co-product accounting? Which method do you recommend for the Gold-Mining industry (explain your response)?