Happy Bids,
<<Correct me if I'm wrong, but when they borrow the gold, isn't ABX short-selling the gold at the given price, in this case $385. Thus, if the current market is $285 and ABX returns x ounces of gold to the CB/GB, didn't they just Short at $385 and Cover at $285 for a profit of $100 per ounce above spot?>>
Basically no. Let me explain. It would be erroneous to apply the traditional paradigm of short-selling to what ABX is accomplishing in the market place.
1. They barrow gold from CB's and sell it immediately at prevailing market spot (so there is no short contract that stipulates $385, see below for explanation of where $385 comes from). This has created a $4 billion asset for ABX as of Q1 '99.
2. They immediately redeploy the $4 billion in asset into money markets earning on average 7.5% interest (called Cantango).
3. They take future production (at continually lower costs) and repay the GB/CB for the earlier gold leases/loans earning even more profit.
4. If gold rises higher than spot+cantango they defer the gold lease/loan for up to 10 years and pay interest. While selling their production at higher market spot.
It is similar to short-selling, Yes; however, is it as risky? NO WAY.
There are risk we should consider, like the following:
1. If ABX looses their discipline in hopes of higher return (1% increase in cantango=$40MM in additional revenue)and invest in higher Beta instrument they could loose substantial amounts if markets move against them; however, ABX's credit and cash on hand would mitigate small and medium mistakes (although the stock price would pay a penalty).
2. If they incur substantial cost from deferring their CB/GB contracts (I am not clear on what cost ABX incurs for deferring or cancelling, anyone have the answer?).
3. Dramatic decrease in production due to war, natural disasters etc. that constrain revenue.
Let me revisit your question about short-selling at $385. The $385 is a forward looking low end estimate of the average price of gold sold (formula is 385=[(CB gold sold at Spot)+(Cantango: interest earned)-(interest expense paid for gold lease)]/(number of ounces sold). Where Cantango is the lowest no risk rate of return on money markets (~4-6%); however, ABX has been averaging 7.5% so I believe the average price of gold sold for ABX will be higher than $385.
This might not be forward selling but it still depresses the current market for gold. I would agree with Ron Everest and Greenspan, that the price of gold will not make a significant move (could stay low for years) as long as CB's are poised to lease/lend gold to the market to meet the supply imbalance.
The only way prices will rise is an exogenous shock to the stable system we are tenuously maintaining or endogenous existence of inflation or diminishing productivity (which will lead to inflation).
Whatever happens ABX's profitability and net earning for shareholders will increase in the coming years for the following reasons:
- As money supply contracts ABX will improve Cantago (will earn higher interest on the its $4 billion assest).
- Depreciation and amortization cost will improve for the mine in Peru. Hence ABX will extract even a larger gain from the US$39 cash cost.
- When gold prices improve (asset prices in gold sector would be too high to entice ABX to aquire) ABX's capital expenditure would slow adding more earning. They are making the right investment now while there is cheap money and low gold prices.
There are more reasons and if you want I can share my perspective with you at a later time. I don't think I have the patience or the time to write all of it coherently now (I am at the red carpet lounge at O'hare).
Cheers,
Exsrch |
