Barrick (ABX) and Hedging

Barrick Gold Corp.(ABX), has made a hostile takeover bid for rival Placer Dome Inc. (PDG). Now hedging has become an issue.

In rejecting Barrick’s $9.2-billion (U.S.) offer Wednesday, Placer chief executive officer Peter Tomsett took a run at Barrick’s hedging practices, saying they exposed Barrick shares to “risk and uncertainty” and could significantly hurt Barrick’s future financial results.Barrick fired back that its percentage of reserves committed under hedge agreements is almost exactly the same as Placer’s, and that Barrick has been steadily whittling down its hedge book since the end of 2001 while Placer’s overall hedge position has increased over the same period.

Gold producers use hedge agreements, or forward sales contracts, to protect themselves from flat or falling gold prices and also to help secure financing for new mines.

Many mining companies borrow money from the banks to develop mining properties. The banks who are risk averse require the mining companies to sell the future production forward, which means that a company sells its future production today at, say $550 per ounce. This works great for all concerned if the POG stays at this price or goes down, because you sold it all at $550. The rub is that POG goes to $650 and the mining company doesn’t pick up that extra $100 per ounce.

Hedging helped Barrick’s financial performance during the 1990s. But when the price of gold began to rise this decade, many investors began to shun hedged producers in favour of those who could sell all of their production at spot prices.

For twenty years POG was in a bear market and hedging worked just fine and Barrick was one of the few profitable gold mining companies. The POG bottomed at $250 in 2001 and has since doubled. IMO the POG will be higher than the Dow Jones Industrial average in the years ahead and hedging is a guaranteed loser. Most investors in gold mining shares shun companies that hedge their production. After all, we take all the risks involved in the mining business, mines can flood, there can be environmental risks, labor strikes, political risks and mines can give out. We want the ability to make obscene profits if our scenario for the POG works out.

My sources tell me that Barrick may be as much as $3 Billion offside on its hedges. Meaning if Barrick was forced to buy back its hedges it would cost them $3 Billion more than they received. That is $3 Billion that should have benefitted the shareholders. I believe that their troubles are only beginning.

GATA has warned mining companies for years to get rid of their hedging. Many have done so including the largest Newmont (NEM)*, but Barrick and Placer Dome have not. GATA has also warned that that central banks and bullion banks are short 12,000 to 16,000 tons of gold, meaning the gold has been borrowed (leased) and sold. Now some leasors want their gold back and supplies of gold used for price suppression are half of what is declared publicly. It’s a huge impetus for huge price increases.

*Newmont has inherited some hedge agreements through acquisitions.

Barrick Placer Dome Newmont gold

Update: From Vietnam we learn that real estate has been so hot that many borrowed gold, sold it and used the proceeds to buy real estate. Now the POG has jumped and they are in trouble.

Ngo Xuan Quy from Tan Phu district, Ho Chi Minh City, one such individual said that the gold price was VND 890,000 per tael when he borrowed gold but it has now risen to VND 940,000 per tael, equating to a loss of VND50mil over half of month.

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