Newmont Mining Corp (NYSE:NEM) is one of the world's largest gold miners. On the surface that seems like a pretty simple business model. And it is, until you dig down a little deeper. Let's dive in to what it takes this gold titan to make profits shine.
Dig hole, repeat
Mining isn't too complex. You dig stuff out of the ground, process it a little bit, and then sell it. Do that over and over again and you have a business. But while that may be enough to get you started in understanding what a company like Newmont Mining does, it only scratches the surface of the whole process.
The first thing that you have to do when you are looking to open a gold mine -- or copper mine, since Newmont is in both businesses -- is to find a good spot. That means geologic research to make sure there's actually something worth digging up. This is an important step, since setting up a new mine, or expanding an existing mine, is a time-consuming and expensive process.
That's doubly true if Newmont is looking to acquire a mine or mine site. The price of a mine will vary depending on how much material can reasonably be retrieved from the mine. It's worth noting, too, that this isn't a one-time effort. As Newmont pulls materials from its mines, it has less gold and copper to mine in the future. The future materials are called reserves, the amount pulled out in any given year is called depletion. So unless Newmont is constantly on the lookout for new sources or opportunities to expand existing operations, it will eventually run out of reserves and, effectively, stop being a miner.
Right now Newmont is working on six projects and mine expansions at or near existing facilities, including two that should come on line this year, one next year, and three the year after that. They are relatively low cost but have a high probability of achieving Newmont's goal of maintaining production levels over the next couple of years. Their success can pretty much be gauged by the miner's annual gold stats. If production remains stable or heads slightly higher, Newmont's on the right path with these six projects. If production declines, there are problems and you should do a little more digging.
No gold nuggets flowing down a river
And while the idea that you dig a hole and pick up gold nuggets is romantic, it isn't true. Yes, at one time, you probably could find gold that way, but just like pan handling in a river, gold is much harder to get at these days.
For example, Newmont Mining uses processes such as milling, heap leaching, processing in a flotation plant, and bio-milling. What? The easiest one of these to understand is milling. Basically, "the ore is ground into a fine powder and mixed with water into a slurry, which then passes through a carbon-in-leach circuit..." I had you up until that last part, right? Basically a chemical process is used to get the gold to attach itself to carbon so it can be easily isolated in a later stage.
And that's the simple process. For example, bio-milling makes use of "naturally occurring bacteria strains" to help isolate the gold for further processing. You don't need to understand the science behind all of this, thank goodness, but you need to understand that as the processes get more complex, costs go up. So milling is relatively inexpensive, but bio-milling isn't. That can materially change the economics of a mine, and have a big impact on profits.
What mining method gets used depends on a mine's ore characteristics. For example, mines that produce ore with high levels of carbon or high level of sulfide materials won't respond to traditional methods that make use of cyanide. Thus other ways of extracting the gold are needed to overcome these obstacles.
More than just digging
But there's a lot more that goes into mining than just finding gold and copper and processing it, although those are core to the business. For example, the industry uses a metric called all-in sustaining costs, or AISC for short. This metric essentially shows what it costs the company to get an ounce of gold or copper out of the ground and into a customer's hand.
It takes into consideration mining and processing, of course, but also other factors. For example, a mine can't just be left after Newmont is done with it. Mines have to be properly closed down and returned to a more natural state. Although not paid right away, the company sets money aside for such costs over time.
There's also costs such as accounting, sales, and management that aren't directly tied to pulling gold and copper from the ground, but that are necessary for the company to run its business. And of course Newmont has to make sure its equipment keeps running properly, which is another cost that goes into AISC.
In addition, Newmont also pays companies, called smelters, to turn its gold into products like bars and ingots that can be sold to end customers. In other words, there's a lot of little things that go on between the mine and the final product, and all of that impacts Newmont's costs.
So far we've broadly discussed what it takes to get gold and copper from the ground and into a customer's hands. But there's an elephant in the room that we've ignored. And that's the fact that gold and copper are both commodities subject to often swift and extreme price swings.
Until 2007, Newmont used hedges to lock in future gold prices so it didn't have to worry as much about price volatility. That's both good and bad, however, because it meant the company would be protected when gold prices fell, but wouldn't participate as much when gold rallied. With the hedge book gone, the miner's earnings are now highly dependent on the price of gold.
When gold prices are high, Newmont can make a lot of money. When gold prices fall, however, its profits can quickly evaporate. But that's only part of the story. This is because gold, and copper, prices change everything about the business. For example, Newmont's mines had an all in sustain cost of roughly $1,000 per ounce last year. However, it's Phoenix mine had an all in sustaining cost of $1,200. If gold were trading at $1,100 an ounce, simple math tells you that the Phoenix mine wouldn't be making money. Do you keep running the mine, close it down, or try to reduce costs? In lean times those questions can meaningfully change the company's business plans.
The price of gold also alters the company's expansion plans. If gold prices are low and expected to stay low, high cost mines aren't a good acquisition option. Nor are expansions at existing mines with higher operating costs. In fact, if commodity prices fall far enough, any expansion could be an unprofitable affair. That doesn't mean Newmont won't put the dollars in, since it has to invest or risk running out of gold and copper to mine (depletion). But when gold prices fall, opportunities that once looked promising can start to tarnish.
Because gold and copper are commodities, however, there are large and liquid markets for their sale. So Newmont doesn't have to worry so much about finding customers or intermediaries to sell its gold. There are plenty of companies willing to do it, and generally enough demand in any given period that it will be able to sell its wares. What price it gets is another issue -- but finding customers isn't the biggest problem the miner faces.
A lot of moving parts
When I think of gold mining, the first thing that pops into my mind is old movies about the California Gold Rush. Some hairy old man, usually with a curmudgeonly attitude, digging around in a cave for a bright and shinny vein of gold. So much for the movies reflecting reality, at least today. In fact, who knew that getting gold out of the ground was so complex? Newmont Mining knows, and now that you know, you can determine if Newmont makes sense for your portfolio.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.