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Gold/Mining/Energy : Gold Price Monitor -- Ignore unavailable to you. Want to Upgrade?

To: Ken Benes who wrote (59772)	10/13/2000 2:59:02 PM
From: Alex	Read Replies (3) \| Respond to of 116762

The multiplier effect of gold hedging ABC Mining Company has completed a bankable feasibility study that concludes that for an investment of $500 million, ABC can develop a mine that will yield gross revenues of $1 billion over the next 10 years. ABC needs to acquire the money to develop the mine, which must be entirely off balance sheet and without recourse to any of ABC's current assets. ABC is aware that it can lease 1.8 million ounces of bullion for less than 2%. Its bank has agreed that upon the lease of the bullion ABC may sell it to generate cash sufficient to finance the mine. ABC assumes the liability to return 1.8 million ounces at some predetermined time in the future. Let us assume it is 10 years after the initial lease. The investment bank turns to a central bank to obtain the physical gold it will lease to ABC. The period of time that the central bank leases the gold that will facilitate this transaction cannot exceed one year. The agreement with ABC includes an assumption that the investment bank can continue to "rollover" its lease of the bullion. If this investment bank, which has accepted the responsibility of the rollover, cannot obtain the gold to lease on the anniversary of its original transaction, then ABC may need to return the bullion received. At the inception of the project, the conservative CFO of ABC may wish to make sure that the profit margin anticipated during the project review is not dissipated through a declining market for gold. The CFO will likely hedge the profit by selling anticipated yearly production using mechanisms such as sales deferred forward. At this point, when the project has not yet begun and the gold is still in the ground, the anticipated production over the next ten years is sold. Additionally, the leased gold was sold to finance the mine construction. ABC has already sold more gold than it may ever mine. At some point in the future a conscientious CFO might consider buying calls designed to offset the risk of a rising gold price. In fact, the real world example of this wise tactic can be seen through Barrick's financial strategy. Assuming there are no unexpected economic events, once the mine is built and the gold is produced, it is then sold and the relating hedge positions are closed out. The ratio between the leased bullion and the actual sales is very much dependent on the firm's financing needs and the projected profit the company wishes to protect. The point that needs to be understood is that this typical chain of events will result in the sale of several years of production (and then some more to cover the leased bullion) before the first ounce is pulled out of the ground. This financing strategy creates a magnitude of supply that makes the continuation of the declining market for gold self-generating. As the price of gold continues to sink into its own abyss the financial worthiness of these companies will begin to falter. The resulting scrutiny of the industry may have a domino effect on the companies. This scenario is dismal enough. An alternative scenario is that due to some unknown event, the supply of gold by the central bank to the investment bank for leasing is reduced. The resulting scurry by the investment company to obtain gold to roll-over or the attempts by the producing company to purchase bullion to return against the lease could generate sufficient demand and excitement to cause the price of gold to skyrocket. The resulting margin calls to the industry could decimate all firms that have not hedged both sides of the market. It is my fear that the number of companies truly protected from such a scenario represents a small fraction of the industry. You can comment on this article by clicking on the link at top right By: Jim Sinclair mips1.net