Gold Is on the Rise, So What's Bugging Barrick?
by KURT EICHENWALD
New York Times
March 2, 2003
[AN EXCELLENT DETAILED ACCOUNT ON BARRICK AND BLANCHARD]
THE economy is in the doldrums. The stock market is a mess.
War looms. Terror threatens. In other words, it should be
time to celebrate at companies in the business of mining
gold, long a haven in periods of investor anxiety.
But one of the industry's largest players, Barrick Gold of
Toronto, hasn't been popping any Champagne corks of late.
After years of top performance, Barrick's stock price has
slid, falling nearly 11 percent over the last year, as
prices for gold have soared nearly 18 percent. Randall
Oliphant was recently shown the door as chief executive and
replaced by another longtime Barrick executive, Gregory C.
Wilkins. Now, Barrick has been sued by a gold dealer and
gold investors who say its success of the last decade
relied on manipulating gold prices.
At the foundation of many of its troubles is a wide
perception among investors that Barrick is not set up to
take advantage of a rising market because of its strategy
of locking in prices for future gold production. That
strategy - known as taking a hedge position - has been used
by Barrick for some 15 years, and company executives credit
it with bringing in some $2.2 billion of additional profit
during that time.
As the industry's glitter returns, investors fret that the
hedging strategy might turn Barrick's gold into dross. "By
far the biggest imputed liability to the stock price we
estimate is related to concerns about the hedge book," said
Chad Williams, a mining analyst at Westwind Partners, an
independent institutional brokerage firm in Toronto.
Indeed, in a recent conference call, Mr. Wilkins
acknowledged that Barrick's hedge had become something of a
"lightning rod" among investors. But company records, as
well as interviews with mining and finance experts, suggest
that the strategy will not have the negative impact on
Barrick's near-term financial performance that investors
fear. Ultimately, Barrick's largest risks come from the
legal challenge it faces and from issues like production,
lease rates for gold and whether it will miss out on a
higher price a decade into the future.
Barrick is cutting back the size of its hedge position. It
now has about 20 percent of its 86.9 million ounces of gold
reserves committed to hedges, down from about 26 percent
last June, according to Jamie C. Sokalsky, its chief
financial officer.
Still, for gold bugs, who approach investment in gold with
a fervor bordering on religiosity, the use of any such
hedges, which entail the sale of borrowed gold into the
spot market, is a heresy that damages the marketplace.
Hedgers, led by Barrick, have warred with nonhedgers for
years.
Recent events have only fueled the debate. With a strategy
described in exotic terms like "off-balance sheet position"
and "fixed-forward contracts," the hedge program sounds the
way the kind of toxic ploys used by Enron did. For
conservative gold investors, they are the equivalent of the
investment bogyman.
"As a percentage of Barrick`s total assets, its
off-balance-sheet assets make Enron look like a champion of
full disclosure," said Donald W. Doyle Jr., chief executive
of Blanchard & Company, a gold dealer in New Orleans that
is the lead plaintiff in the suit against Barrick in
Federal District Court there.
Barrick insists - and numerous analysts agree - that its
strategy is far simpler and more adaptive to market
conditions than investors seem to believe. It begins with a
contract between Barrick and a large bullion dealer, like
Citigroup or J. P. Morgan Chase. Under the terms of the
contract, Barrick is required to deliver gold at some
future date. The contract, known as spot deferred, allows
Barrick to postpone delivery, however, for up to 15 years.
With the contract in place, the bullion dealer then leases
that same amount of gold from a central bank, selling it in
the spot market. The dealer then effectively places the
cash from the sale on deposit, where it earns interest.
During the contract's life, the dealer pays interest to the
central bank as a fee for borrowing the gold. Once Barrick
delivers the gold, it receives the cash from the spot sale
and the accumulated interest, less the lease rate and
certain fees paid to the dealer.
That can give Barrick strong protection against a falling
market. If the spot price is $300, for example, the hedge
strategy could lock in a price five years in the future of
about $345. If the spot market is higher than that price,
Barrick can sell its gold there and defer the delivery
against the contract. As a result, Barrick, on average, has
made about $65 an ounce above spot market prices on gold
sales the last 15 years, the company said.
Barrick, which analysts say has the mining industry's
highest credit rating, has been able to gain particular
advantages in its deals with bullion dealers. It is allowed
to deliver gold against its hedging contracts at virtually
any point, whether in 2 days or 15 years. In addition, if
the dealer agrees, Barrick can "reset" the time limit every
year, starting the clock over on the 15-year deadline. If
the dealer refuses, which Barrick says has never happened,
delivery would be required 14 years later. Most important,
Barrick does not have to post cash - known as margin - if
the price of gold rises significantly.
It is those features that make Barrick's program far
different from hedging efforts that have hobbled other gold
producers. For example, in 1999, when gold prices spiked
unexpectedly, margin calls and other immediate financial
consequences brought Ashanti Goldfields of Ghana and
Cambior of Canada close to ruin - troubles that the Barrick
program is structured to avoid.
None of this is free of risk. If gold's spot price rises
above the hedge price for more than a decade, Barrick would
be forced to sell its gold for less than its nonhedged
competitors would receive. Moreover, the bullion dealers
could demand delivery if Barrick violated certain financial
and performance requirements - for example, if a disaster
occurred at its production facilities that impeded its
ability to deliver gold.
The hedging strategy also now faces a legal challenge. In
the federal lawsuit filed late last year, Blanchard and the
other plaintiffs accused Barrick of using its hedge program
to manipulate gold prices in violation of federal antitrust
laws.
In essence, the lawsuit says Barrick and J. P. Morgan
Chase, which has participated in the hedge program for
years, used the strategy to force down prices, allowing
them to profit at the expense of other market participants.
"If you look over the past six years, you will see that
when Barrack's hedge position has gone way up, the price of
gold has gone way down and vice versa," said Mr. Doyle of
Blanchard. "Barrick created an anticompetitive environment
through the manipulation of the price of gold, and they did
it with the knowledge and assistance of J. P. Morgan and
perhaps some of the other bullion banks."
With the hedge program bringing future sales of gold into
the immediate spot market, Mr. Doyle said, Barrick had the
ability to cripple any rally in the price of the commodity.
Because the program also allowed it to profit in markets
that left competitors in poor shape, he said, Barrick was
able to use its competitive advantage to acquire other
companies, fueling huge growth.
So while he is no fan of Barrick, Mr. Doyle says investor
concerns about the hedge program's impact on the company
are misplaced - a conclusion largely based on his belief
that Barrick still has the power to manipulate prices. "The
risk to the company from the price of gold going up is not
all that great. so long as Barrick still has the ability to
push the price back down again," he said.
A spokesman for J. P. Morgan Chase declined to comment.
Barrick, which has formally notified Mr. Doyle that it
intends to file a slander suit against him and Blanchard,
dismissed the accusations in the suit as nonsense. "Eighty
percent of our gold is not subjected to any hedge, so we
are delighted with gold prices rising," said Mr. Sokalsky,
Barrick's finance chief. "For us to hope against the value
of our commodity going up would be crazy."
Moreover, antitrust experts who reviewed the Blanchard
complaint said that they did not hold out any expectation
that the suit would be successful, primarily because it
misapplies antitrust laws.
"The antitrust laws are here to protect competition, not
competitors," said James Mutchnik, a partner at Kirkland &
Ellis in Chicago and a former prosecutor with the antitrust
division of the Justice Department. The plaintiffs "are
complaining of lower prices in the market, and that is
exactly what the antitrust laws are trying to accomplish,
which is to benefit consumers rather than gold retailers."
he said.
Mr. Doyle said the antitrust claim was also based on what
he described as Barrick's ability to use the hedge program
to drive up prices at particular times, essentially by
announcing its intention to suspend its use. "With their
spot-deferred contracts, they were in the position to push
up the prices periodically," he said.
But some analysts said that proving that Barrick's hedge
program significantly affected gold prices long term would
be challenging because of the many factors underlying them.
"Anyone with a legitimate understanding of how the U.S.
dollar-denominated gold price is derived would not target
any producer or any central bank for manipulating it," said
Mr. Williams of Westwind Partners, which receives no
banking fees from Barrick. The price, he said, "moves
mostly on the U.S. economy, interest rates and inflation."
Indeed, it was signals from such economic indicators that
led Barrick to cut back its hedge position, according to
Mr. Sokalsky. Hedging "is a tool as opposed to a religion
for Barrick," he said. "And we have been adjusting it to
reflect changing economic and financial situations. And
with the gold price going up, the reduction of our position
has been a good decision, in hindsight."
nytimes.com |
