exposing megahedger Barrick Gold -- tiny CEO shareholdings
For a cogent explanation of the rationale for hedging, look no further than the 2001 Barrick Gold annual report. Within the footnote on derivative instruments (page 81), it states: “The Company’s risk-management program focuses on the unpredictability of commodity and financial markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on its operating results.” In other words, Barrick management prefers to be agnostic on the subject of gold prices. Fine, but that’s not what investors want.
For an explanation of this apparent divergence between management actions and shareholder interests, refer to the Barrick 2001 proxy statement. It shows that corporate management has a very small personal financial commitment and stake in the performance of the shares. Commitment is evidenced in shares held outright. An option position, which costs the manager nothing but entails potential dilution risk for the shareholders, invites opportunism. For example, the Barrick CEO owns outright only 10,200 shares, worth approximately $200,000 at today’s market price. For an executive earning US $1.4 million a year, this miniscule share position does not pass muster as an incentive. Barrick is not the only example of a divergence between management and shareholder interests. A similar pattern can be discerned in the proxies of other hedgers.
One could infer as a possible and charitable explanation for this disconnect that the managers equate stable, predictable cash flows, which might translate into the financial strength necessary to build a bigger enterprise from which all stakeholders might benefit, including shareholders. An important reason for the rise of gold hedging during the 1990’s was the generational transition in senior management. Hard-core gold bugs, who failed to generate returns on capital within a declining gold price environment, were replaced by no-nonsense apparatchiks who saw gold as just another commodity. The 1990’s culture in which both financial engineering and stock option packages thrived goes a long way to explaining both why the new breed of management cared little about gold as money and their willingness to pursue dilutive acquisitions (Homestake-Acacia, Anglogold- Normandy, and now, Placer Dome-Aurion, for example).
One could infer as a possible and charitable explanation for this disconnect that the managers equate stable, predictable cash flows, which might translate into the financial strength necessary to build a bigger enterprise from which all stakeholders might benefit, including shareholders. An important reason for the rise of gold hedging during the 1990’s was the generational transition in senior management. Hard-core gold bugs, who failed to generate returns on capital within a declining gold price environment, were replaced by no-nonsense apparatchiks who saw gold as just another commodity. The 1990’s culture in which both financial engineering and stock option packages thrived goes a long way to explaining both why the new breed of management cared little about gold as money and their willingness to pursue dilutive acquisitions (Homestake-Acacia, Anglogold- Normandy, and now, Placer Dome-Aurion, for example).
Contrast the Barrick example to the manager-shareholders of Franco Nevada who hold a substantial personal stake in the enterprise. Having tried once only to fall short of achieving a merger with Goldfields of South Africa, Seymour Schulich and Pierre Lassonde engineered the three-way merger between Newmont, Normandy, and Franco. The stated objective was to convert their personal wealth in Franco into an unhedged entity with full upside exposure to gold. This strategy and vision was, in my opinion, an important reason why Normandy shareholders preferred the Newmont proposal to that of Anglogold, a prominent hedger. Other examples of pro gold, staunch anti-hedging managements with significant equity commitments are Harmony, Goldfields, Iamgold, Goldcorp and Agnico Eagle. (This is not an all-inclusive list and I apologize to the many I failed to include.)
At the end of the day, hedging was nothing more than a devious and complicated way to finance a declining business. Complexity in monetary matters, in the words of John Kenneth Galbraith, ”is used to disguise truth or to evade truth, not to reveal it.” The truth about gold hedging is that it is a short sale, which can be covered in only two ways. First, it can be covered as gold produced by mines is repaid to the bullion dealers, who in turn repay the original central bank lenders. However, this method of repayment takes time, often years. Such a delay might be excruciating in a rapidly rising price trend. What is also interesting about this method of repayment is that it actually reduces the supply of gold because gold earmarked for repayment never hits the market. The second method of repayment is outright purchase of physical gold on the open market. If done in an orderly, measured fashion, open market purchases are probably feasible. However, if all the shorts get the idea at the same time, it would be very difficult to cover because the amount of this short interest is at the very least 4,000 tonnes, or more than 1.5 years of new mine supply.
What is happening in the gold market currently is that the hedged mining companies, after having taken a pasting in the form of share underperformance and vocal criticism from the investment community, are beginning to capitulate. Recently, Durban Roodeport, a South African mining company, raised cash through a new share issue. The use of proceeds was to purchase gold on the open market in order to close out its hedge book. Other miners have been quietly writing puts at strike prices below the market, in the hopes that they will become long gold on pullbacks. However, the proliferation of puts only serves to put a floor beneath the market. Several prominent hedgers, including Anglogold, have reduced their hedge books and numerous others have stated that, at the very least, they will not increase their hedge books and are in the process of reviewing their hedge exposure. The intellectual case for hedging appears to be in tatters and there appear to be very few who would advocate it vociferously. The recent rise in the gold price has all the appearance of a slow motion short squeeze, which could well get out of hand if too many rush for the exits.
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full article
gold-eagle.com
by John Hathaway of Toqueville Gold Fund |
