What does "gold reserves" on a gold mining company's balance sheet mean?

Question

From a Reuters article:

On Wednesday, [Newmont Mining Corp] reported gold reserves of 68.5 million ounces for 2017, unchanged from 2016, as it replaced reserves through exploration, projects, revisions and acquisitions.

68,500,000 ounces divided by 35,274 (metric ton conversion from ounces) equals over 1,900 metric tons. That can't be possible, as that's in the billions of dollars and would imply the company is underpriced.

What is "gold reserves" on a balance sheet in this case defined as?

Answer 1

For gold mining companies, the amount of gold that the company has access to but has not yet been mined is accounted for in "reserves". The company can claim a percentage of those reserves as assets, but must spend money to mine them. That is why the market value of those reserves is not entirely reflected in the value of the company. The actual value must be reduced by the cost of extraction, and adjusted for the possibility that there isn't actually that much gold underground.

if they really have as much gold as they claim, they'd be underpriced.

Suppose your neighbors have a suitcase with $1 million buried in their backyard. You estimate that it would cost $400,000 to dig up the suitcase. What would you say their property is worth? Would you say that it's underpriced if it's valued at $600,000, even though there's $1 million in the backyard?

Answer 2

Gold reserves refers to gold in the ground that a mining company has an option to retrieve.

68 million ounces is a lot! And yes, a mining company's value is partially dependent on the size of their reserves. But it costs an exorbitant amount to retrieve gold. Newmont are projecting costs of $700-$750 per ounce in 2018, and this doesn't include their exploration costs - their all in operating costs are projected to be $965 - $1025.

• Most obviously, the miner must get that gold out of the ground and process it. This isn't finding a gold nugget on the ground - the majority of commercial gold mining operations extract gold from ore at scale, moving lots of rock.
• The quality of the ore is measured in g/T - grams per tonne. A few grams per tonne is a reasonable grade. A gram per tonne is a tiny amount - a millionth! One of those huge mining trucks will haul perhaps two hundred tonnes; if the grade is a reasonable 1g/t then you might get a potential 200g of gold per truck, which is about 7oz. Note that the processing will never retrieve 100% of the gold from the ore.
• The truck has to drive from a mine site (perhaps an open pit) to a processing plant. The processing plant will be far enough away from the pit so that it doesn't need to be moved as the pit expands. The truck will have to descend/ascend via a long, low incline 'road' as it can't pull a full payload up a steep incline. Each truck will make a limited number of loads per day; it's not a 5 minute round trip.
• The processing equipment is expensive, specialized, and requires constant tuning depending on the grade of the ore. Harder rock, softer rock, different compositions - lots of equipment depending on different scenarios; lots of specialists constantly optimizing. Under-optimize and you don't extract all the potential gold.
• You get diminishing returns on your fixed costs as you scale up, so can't build an extraction process to handle tens of millions of ounces per year. You don't want to spend hundreds of millions building a mine for just a few years of operating life. But a longer life yields more uncertainty over future value.

The size of the reserve is useful information, but more important is the cost of extraction. The grade is far more important in driving cost - high grade ore means less rock needs to be dug up, driven around, ground and processed - or the hole doesn't need to be as deep.

You'd have to check Newmont's record of meeting their cost guidance to have confidence in it, but if their total cost is ~$1000/oz, and the current price is ~$1300 (and of course they will have to lock in contract prices at various points to avoid being completely at the mercy of the market) they are at best getting $300/oz. Returns that stretch a long way into the future are really hard to value. Often gold reserves are in countries with less stable political systems which can increase cost of operation.

Newmont has a $20bn market cap right now. If you take their 68 million ounces @ $300 profit per ounce, they only have a potential future lifetime profit of $20bn!