Why and how Barrick Gold has singlehandedly destroyed the gold market:
LAW AND ORDER
In a wasteland far more vast than when the term was originally coined more than 4 decades ago, TV does offer a respite from the garbage that passes for entertainment, in the weekly series, "Law and Order". This is a well-produced, well-acted series that is no-nonsense. It depicts in detail the workings of the police and prosecutors in New York in investigating serious crimes and in proving guilt and exacting punishment. I'm a big fan of the show. In thinking of why this show stands out to me, I come to the conclusion that it is a fantasy for thinking adults, much like the fantasy that Disney is to small children. Fantasy? Well, think about it. Although the occasional criminal gets off by a technicality to make it look realistic, the fantasy aspect is still clear. The fantasy is in the depiction of the police and the prosecutors as unrelenting in the pursuit of justice. Don't misunderstand me - I'm not maligning the real dedicated public servants that risk their lives and toil their entire work-life in the service of their fellow man. I'm talking about the TV show and how the message is continuously delivered - you can count on the fact that we're here to ferret out crime and punish the offenders with high principles and passion. Many shows even portray a struggle between different jurisdictions for the right to prosecute. I, for one, enjoy the fantasy. I like thinking that they are always there for me. It is how our law enforcement officials are supposed to behave in the ideal. They have taken an oath of office to do the right thing.
That's why I'm so upset and disgusted with the Commodity Futures Trading Commission (CFTC). They are the police and prosecutors rolled into one for the commodities industry. All commissioners and senior officials of the CFTC have also taken an oath of office to uphold the law. While the CFTC doesn't deal in violent crimes, manipulation is their Murder One. Forget the fantasy - you would think that a minimal level of expectation would dictate that a bona fide allegation of serious wrongdoing would be addressed, not shamefully ignored. To date, I have not received, nor heard of any specific response to my allegations about Barrick Gold Corp violating the intent of the Commodity Exchange Act (CEA) by forward selling years of production. There was a mass electronic mailing to those who took the time to contact the CFTC as a result of my article, "The Death of Hedging", but no attempt at dealing with the specifics of my allegations. For what it's worth, I have personal knowledge that the form letter sent to everyone was the same letter sent to a friend who contacted the CFTC about an article I wrote months before, in which I didn't raise the issue that years of forward selling violated the CEA. In other words, the CFTC didn't even take the time to write a new denial form letter for the new allegations. Sometimes I think each employee has a big rubber stamp marked "NO MANIPULATION" for quick dispatch of public complaints. So much for the fantasy of the TV show and dedicated public officials. The only consolation is that the manipulation of gold and silver, via the leasing/forward sale scam, is becoming so obvious and clear, that when it explodes on the market, it will be hard to imagine senior officials of the CFTC not doing jail time for their malfeasance. I don't know how to accuse them in stronger terms. And it is not for them to decide to abide the manipulation to protect other markets - their job is to uphold the law, period.
Silence also seems to be the preferred choice of Barrick Gold Corp in dealing with my allegations that they have violated the intent of commodity law and are ringleaders in the gold and silver manipulation. I try to imagine the reaction of a company unfairly accused of a serious infraction, and silence is not one of the choices that comes to mind. Here's a 7 billion-dollar mining giant reduced to silence by an unknown individual - go figure. For the record, I did contact Barrick before I released this article, offering them the opportunity to respond in advance with any refutation or clarification, but guess what? - Silence. Also for the record, I'd like to repeat that I've never owned or shorted Barrick in any form, nor do I intend to. I have zero financial interest in this company. Let me be clear why I am targeting Barrick. I am trying my best to force them to cover their manipulative and illegal short position in gold. Nothing more, nothing less. I feel if I can succeed in doing this, I can end the leasing/forward sale scam that I have written about for years. If I can force Barrick to cover, all the dominoes will fall, and we'll have a free market in gold and silver for the first time in more than a decade.
I intend to apply more pressure on Barrick here, but first I'd like to comment on the reaction of Barrick defenders to my attack to date. About the only reaction by Barrick defenders that I've seen is that they take issue with my characterization of their forward sales as shorts, instead of hedges. I feel the point is moot and detracts from the larger issue, namely is this multi-year production sale illegal and/or even desirable from a shareholder point of view? The question of legality is up to the cowering CFTC. The issue of desirability is up to the shareholder, existing or potential. What shareholder would want this company to be pre-sold for four years at 20 year low, below cost of production prices? It doesn't matter at what price Barrick sold the 13.3 million ounces; it matters where the price is now. What legitimate company wouldn't close out a sell hedge below the real cost of production? This may sound bizarre, but some might consider me a great friend of Barrick (shareholders and employees, not management) - if they did cover their short position here, what a jewel this company would be going forward. I think the defenders of Barrick haven't thought this through, or can't admit publicly that they secretly prefer Barrick to close out this obscene short position right now.
Leaving the short position aside, there are two other factors that I ask Barrick shareholders to consider, in the hope of them applying pressure to management to close out the short. These are factors that are not widely discussed and could have a great impact on the company going forward. First, is the nature of the portfolio of interest bearing issues and derivatives created from the proceeds of the short sale of 13.3 million ounces of gold. Using the company's own figures (web page, annual report and interim statements), Barrick has amassed the equivalent of roughly $5 billion in this off-balance sheet item. The earnings on this investment hoard are what provide the bulk of total income - $200 million out of the total $300 million net income last year. The profit on this portfolio is derived from the interest income earned minus the cost of interest paid for the gold that was borrowed in order to sell short. Barrick trumpets that the net interest spread is roughly around 5% (7.5% collected from investment income minus 2.5% cost of gold loans). This is Barrick's claim to fame. But if I were a shareholder, this would bother me. Not just because this is a hedge fund in drag, but because of the type of hedge fund it really is - one that appears to be betting on perpetual low interest rates.
The big problem with derivatives, as people such as David Tice have pointed out, is that you have no idea who's holding what. You know the total figures are astronomical, but everyone is blind to the composition of derivative portfolios. Barrick is no different in this regard. Their annual report does indicate that they hold around 15% of their portfolio in Total Return Swaps, but other explanations are lacking. (nota bene, Total Return Swaps are the class of derivatives derided by Martin Mayer in the Wall Street Journal Op-Ed piece a few months ago as an example of a financial "perpetual motion machine"). Therefore, one must analyze the results reported in context of the overall investment environment to guess at what Barrick might hold. Barrick has proclaimed on their web page how they are able to earn (due to implied investment acumen) 7.5% gross returns, when similar term returns offer only 5.5%. I have read comments that people actually believe that Barrick invests strictly in US Treasury securities on a cash basis. Folks, there are only two ways known to man how one could goose returns by 40% - employ leverage and/or sacrifice quality (including speculating in derivatives). While these tactics will boost returns in an environment of steady to falling rates and no systemic stress, an environment of rising rates and evidence of stress and liquidity problems would be a killer. Coincidentally, the empirical evidence suggests that we enjoyed the benign environment for many years, and entered into the hostile one six months ago. Stated differently, Barrick was positioned well until 6 months ago, based upon the above reasoning. Further, it's possible that Barrick has taken a huge hit (perhaps many hundreds of millions of dollars) to its off-balance sheet portfolio as a result of the well publicized back up in rates and credit quality concerns. To be fair to Barrick, maybe they navigated through these treacherous waters unscathed, the problem is the lack of reporting on derivative disasters until it is too late. The point is this - as a shareholder, are you consciously making the decision to invest in Barrick's ability to speculate in the world of derivatives going forward? Did you think you owned a gold miner with an exposure to a rising price of gold, or a narrowly focused hedge fund? I have nothing against hedge funds per se, as long as they are labeled as such. Closing out the short position forthwith, and liquidating the hedge portfolio will result in Barrick becoming a gold mining company once again, and a pretty good one at that.
The second factor that shareholders should consider is the direction and level of gold and silver lease rates in the future. Barrick's long term viability is predicated on metal lease rates staying abnormally low - around 1%. While that is how they behaved for the greater part of the past 10-15 years, there are clues that is about to change. The first clue comes from the recent behavior of gold lease rates. For the past few months, gold lease rates have risen to the highest sustained levels in history, some 3% to 4% - an unheard of occurrence. Normally, this level of interest rate would seem low - but remember, we're discussing metal loans, where everything is upside down. To put it in perspective, at 5-6%, Barrick would lose the vig - its whole advantage in borrowing gold to sell short to invest the proceeds would vanish. So, what's the chance of that happening? From my vantage point, the chances are very good. If you really think about the folly of metal leasing, you reach the inescapable conclusion that it must end someday, when lendable metal is exhausted, or something else changes in the equation - something that could be as simple as sentiment. Simply stated, if the lenders of metal change their minds about the wisdom of leasing, and begin to withdraw from the market, lease rates would soar. And when metal lease rates soar, they soar like nothing else. We have witnessed the rates of other precious metals (silver, platinum and palladium), the closest real examples to gold in existence soar to levels of 70%, 150% and 300%, respectively. As it is, even in its almost non-existent state, one-year platinum and palladium lease rates have clung to the 6%-7% level, just high enough to make any borrowing strategy uneconomic. Because of the huge short position in gold and silver created by leasing, a 6-7% plateau would be a dream. It would be reasonable to assume that when gold lease rates explode, a figure 10 or 100 times the current level will prevail.
As a shareholder, are you comfortable with your investment in Barrick riding on something as ethereal as the future gold lease rate? Are you absolutely convinced that the thought of higher lease rates is inconceivable? If Barrick management refuses to cover their hedge now, what are the chances that they will be forced to cover in the future at a more inopportune time than now because of sharply higher lease rates or because of reversals of fortune in their hedge fund portfolio? Do you honestly consider these factors in your ongoing evaluation of Barrick? Let me state my motives once again. I am not suggesting that Barrick stock should be sold, I don't care to give investment advice. I am trying to state clearly that the real owners of the company demand of management that the short position be closed out, and eliminate future uncertainty about derivatives and arcane lease rates. This monster short position has the potential to make or break this company (and others similarly positioned) going forward. Barrick may not have to answer to me, but they should answer to their retail and institutional owners. The CFTC may not have to answer to me, but if this market turns disorderly, they'll wish they had - better me than someone who takes Law and Order more seriously than they do.
Ted Butler
August 26, 1999 |
