The cost of leverage: Gold miners' margins matter

Gold’s ability to maintain its value in the face of rising stock indices and improving investor sentiment reflects lingering concerns over macroeconomic instability, including unresolved trade tensions, high sovereign debt levels and geopolitical flashpoints. Gold’s resilience was impressive considering investment demand, as tracked by the holdings of global gold bullion ETFs, declined in May, down 0.77%. This reaffirms our view that other centers of demand, most notably global central banks, continue to provide support for the gold price in the current environment.

Unlike investor interest, which seems to surge and fade depending on evolving financial market conditions and global macro-economic developments, the official sector’s gold buying appears anchored to a long-term commitment to diversify its reserves and is supported by gold’s role as an inflation hedge and strong performance in times of crisis. Gold closed as high as US$3,431 on 6 May , and as low as US$3,177 on 14 May, ending the month at US$3,289.35 per ounce, effectively unchanged from April’s close of US$3,288.71.

Earnings season highlights operational discipline in gold miners

The gold miners, as represented by the NYSE Arca Gold Miners Index . delivered a respectable performance in May, rising 2.42%. This gain came despite gold’s flat performance and a strong rebound in broader equity markets. May marked the peak of the Q1 reporting season for gold miners, with operating and financial results that generally exceeded expectations across the sector, likely contributing to the equity’s relatively strong performance.

The market is focused on gold miners’ ability to meet their targets, particularly around production costs. Positively, among the group of companies we track, more than 75% reported all-in sustaining costs of production that were in line with, or better than, expected. Consistently meeting or beating production and costs targets should continue to improve investor sentiment toward gold mining stocks and support a re-rating of the sector, lifting valuation metrics to levels more in line with historical multiples.

Margin pressures: Unpacking the drivers of rising mining costs

The market’s obsession with costs is justifiable. Investors own gold stocks to benefit from their leverage to the gold price in a rising gold price environment, but, if at the same time, costs were also to increase, margin expansion would be compromised. During a recent podcast, we were asked an important question: why do production costs tend to increase when the gold price is increasing? Let’s examine some of the main reasons.

1. Royalties – Gold mines across the world are subject to royalties. Most governments collect a portion of the profits of a gold mine that operates in their country in the form of royalties. In some cases, these royalties operate on a sliding scale, so that the higher the gold price, the higher the royalty rate. In addition, royalties can be the result of financing arrangements or a legacy from previous ownership structures. In any case, as the gold price increases, companies face larger royalty expenses, which are included in the cost of production.
2. Profit sharing – Gold mining operations around the world have also established profit sharing agreements with their employees. The higher the gold price, the more profits generated, and the larger the profit-sharing costs to the company.
3. Inflation – Higher gold prices can coincide with higher levels of inflation. This inflation can be widespread, affecting all sectors of the economy, and likely contributing to demand for gold. Or it can be sector specific inflation, caused by a higher commodity price environment which leads to increased demand and competition among miners for labor, equipment, consumables, energy and services as industry activity picks up. In either case, inflationary pressures contribute to higher costs of production.
4. Foreign currency appreciation – A higher gold price can contribute to the appreciation of the currencies of countries that produce it, especially if gold production is a significant part of their economy. Stronger local currencies result in higher US dollar costs for gold miners, as a large portion of production costs is denominated in the local currency.
5. Lower grade – As the gold price increases, companies may decide to mine and process lower grade (i.e., lower concentration of gold per ton of rock) portions of the gold deposit. Production of lower grade material may become economic at higher gold prices, and companies may choose to extract this material and maximize production and revenues over the life of the mine. Although more gold will be mined, it is more costly to produce gold from lower grade material, so unit costs of production will also go up in that scenario.
6. Higher sustaining and exploration expenditures – Higher free cash flow because of higher gold prices allows companies to spend more in maintaining and expanding their operations. Exploration activities may pick up, and sustaining capital expenditures may be accelerated or forced to play catch up after previous years’ deferrals.

Outlook: Rising gold prices, stable costs, stronger valuations

Gold companies are currently producing gold at an average all-in sustaining cost (AISC) of approximately US$1,600 per ounce, translating into an average margin of more than US$1,600 per ounce at today’s gold spot prices, a record for this industry.

For example, Alamos Gold, a company’s AISC has remained relatively stable, which, while gold prices have more than doubled since 2014. This has supported record margins today.

Chart 1: Gold Price vs. Alamos Gold AISC: A decade of expanding margins

Source: Bloomberg, Datastream, ICE Benchmark Administration, World Gold Council, and Alamos Gold (2025E value is based on guidance for 2025, which is between $1,250 and $1,300/oz). Average Gold Price is represented by LBMA Gold Price PM and priced per troy ounce. Total consolidated all-in sustaining costs include corporate and administrative and share based compensation expenses.

While costs will likely continue to increase going forward, we don’t expect costs to explode to the point where margin erosion is of significant concern. Although companies cannot control cost increases coming from factors such as those listed in the first four points above, they can continue to look for ways to optimise their operations and increase productivity to offset some of those cost pressures and help contain costs. Our positive outlook for gold is accompanied by our projection that gold miners’ margins will continue to expand in a rising gold price environment, supporting higher valuations for the gold equity space.