Hello energyplay, <<see John Drizard's Strategies column on Barrick Gold (ABX) Or pick up the Friday edition....>>
"GLOBAL INVESTING: Cutting through Barrick's hedge
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By John Dizard
Financial Times; Oct 11, 2002
In what is often called the "Taliban" or "fundamentalist" wing of the goldbug movement, BarrickGold is reviled as the Great Satan, intent on driving down the gold price through its derivatives activities, in league with either the Federal Reserve, or the Illuminati, or both.
Barrick's position, with which I have agreed over the years, is that all it did with its gold short sales was hedge its exposure to fluctuations in the gold price. Its lenders, seeing more stable cash flows than those produced by other mining companies, provided the money for new mine development at a low cost. This has all been blessed by Standard and Poor's, which gives Barrick a highly respectable A rating.
The goldbug fundamentalists, however, believed that it was Barrick's short sales that depressed the gold price. Holders of physical gold (which they perhaps keep in the dugout with their year's supply of canned food and AK-47 ammunition) were thus deprived of profits, along with share owners in those gold mining companies who did not hedge their production. Even as gold, the metal, continued its long bear market, Barrick prospered. The gold "Taliban" were forced into the caves of occasional conferences and internet chat rooms.
Now, for whatever combination of macroeconomic or geopolitical reasons, the faith-based gold investors have been doing well this year, with both the metal and the stocks of lightly hedged gold mines rising in the double-digits.
The rise in the gold price alone should not be unwinding the Barrick story. If all the company was doing was locking in future cash flows to meet fixed expenses, then it still had much gold production available to sell at the new, higher, spot prices. As Randall Oliphant, Barrick's chief executive, says, "We are happy with a higher gold price. That's what we live for."
A higher price is what any gold miner lives for. The catch is that Barrick is only partly a gold mining company. The other part is a large investment company whose accounting codes probably cannot be broken by the National Security Agency, let alone investors or journalists.
And here is the perceived trouble. Because there is a circularity to Barrick's good credit rating, which allows loosely covenanted hedging contracts that provide much of its liquidity. If the banks who lend it gold bullion (for the short-selling programmes), or cash, should decide to rein in the terms of their lending, that could, in turn, reduce the earnings, which support the rating . . . and so on.
That process might have already begun. I have been studying the company's public announcements over this year, an endeavour that would tax even a Jesuit professor of logic, and my findings are as follows. Barrick began using its Premium Gold Sales Programme more than a decade ago. When most people sell gold short, they have to leave the proceeds of the sale, earning low interest, as collateral with the bank that lent the short-sold gold. Barrick convinced the gold lending banks to let it manage the investing of gold sale proceeds. It has been doing this in the "investment company" wing of the corporation.
For most of the past decade it was not hard to beat the interest rates offered to other gold short-sellers on their proceeds. Barrick bought bonds, including corporate bonds, using what are known as "total return swaps" sold by investment banks. These allowed it to earn higher interest rates without requiring Barrick to book timely mark-to-market losses on the value of the bond portfolio. Barrick also earned option premium income by writing (selling) gold calls against its gold production, because its banks didn't tie up that production as collateral.
In the Premium Gold Sales Programme, the extra-high interest and option premium earnings were laid on to the price per ounce that the company received on physical gold sales. Rather than break out the earnings from its investment activities as a separate operation, Barrick distributed them over each ounce of gold sold. Then they were revealed as a higher "realised price" than the rest of the gold industry could earn.
Earlier this year, Barrick started to back off from its corporate bond investment programme. Holding corporate bonds has become a little dangerous. Instead, the company has had to hand over the cash proceeds from forward sales to be managed by its banks and invested in vanilla interest rate products. Someone, perhaps the banks, also decided to curtail the option premium selling, maybe because it reduced their own potential collateral.
In September, Barrick announced it had to lower "guidance" for its 2002 outlook from 42-47 cents a share to 33-35 cents a share owing to operating problems.
At a minimum, Barrick must break out its investment operations in complete detail, along with the terms, including margin requirements, for its hedge programme." |
