From Teeka Tiwari, editor, The Palm Beach Letter: Regardless of the price of gold, producing mines have very high fixed costs. They include salaries, rents, utilities, and other operating costs to keep a business up and running.
When gold prices are very low, high fixed costs can cause devastating losses for miners. But the blade cuts both ways… When gold prices are high, profits skyrocket.
Here’s an example of how operating leverage works… We’ll use a hypothetical company called “Gold Inc.”
Let’s assume it costs Gold Inc. $900 to produce one ounce of gold. And let’s assume Gold Inc. mines 200,000 ounces of gold per year. We’ll set the company’s fixed cost at $30 million per year (salaries, rents, utilities, etc.).
Based on those numbers, the company’s production costs would be $180 million per year (200,000 times 900).
Now, let’s say the price of gold is at $1,150 per ounce.
If Gold Inc. sells 200,000 ounces of gold at $1,150 per ounce, it would generate $230 million in revenue. To get its operating profit, you would subtract production costs ($180 million) from revenues ($230 million).
That would give Gold Inc. $50 million in operating profits.
Next, we’ll get the company’s pretax income. To do that, you’d subtract fixed costs ($30 million) from operating profits ($50 million).
At a fixed cost of $30 million annually, Gold Inc. would generate $20 million in pretax income. Remember, that’s with gold trading at $1,150 per ounce.
Now, what if gold jumps about 22% to $1,400 per ounce?
A 22% move up in gold would increase Gold Inc.’s revenues to $280 million per year (200,000 times 1,400).
It still costs Gold Inc. $180 million to mine 200,000 ounces of gold. But with revenues now at $280 million, operating profit increases to $100 million.
That’s a 100% increase in operating profit from when gold was at $1,150.
But here’s where operating leverage comes in…
Remember, fixed costs remain at $30 million. They don’t change. But the company’s operating profit has increased to $100 million.
When you subtract fixed costs of $30 million from the new operating profit of $100 million, you get pretax income of $70 million.
So, a 22% increase in the price of gold can lead to a 250% increase in Gold Inc.’s pretax income (see table below).
That, my friends, is the power of operating leverage.
Reeves’ Note: In the first-ever issue of Palm Beach Confidential, Teeka recommends a tiny, unique security that enjoys all of the operating leverage of a gold miner—without taking on the operating risk.
The company sports one of the most ingenious business models ever devised… which means its cost per ounce of gold is under $300. Gold’s now trading at over $1,300 per ounce… and rising.
That’s why Teeka says investors have a legitimate chance to make 838% returns on this security over the coming years.