Today's Market Observation 09.21.2009 Mon Tue Wed Thu Fri Kirby Archive
The Thin Edge of the Hedge
BY ROB KIRBY | september 21, 2009
A couple of weeks ago, Barrick Gold Corp. announced it was raising 3 billion dollars via equity issue and taking a $5.6 billion 3rd quarter charge so they could eliminate their 9.5 million ounce “hedge book” over the next 12 months,
Barrick Gold to eliminate hedges, plans offer
By ROB GILLIES
ASSOCIATED PRESS WRITER
TORONTO -- Barrick Gold Corp., the world's biggest gold producer, said Tuesday it plans to eliminate all of its gold hedges and raise $3 billion in a share offering to help pay for the move.
The Toronto-based company cited the bullish outlook for gold. Its announcement came on a day the price of the metal rose above $1,000 per ounce to its highest level since March 2008.
Gold hedges are futures contracts that commit a company to selling the metal at set prices. While hedges guarantee certain cash flows, they often commit a metals producer to ship the gold at prices lower than the current spot price. Barrick's decision to pay off its hedges amounts to a bet that gold prices will keep rising.
Barrick said it believes holding the hedges hurt its appeal among investors and weighed on its share price.
The company said it will take a $5.6 billion charge to its earnings in the third quarter as a result of a change in accounting treatment for the contracts.
To raise money for the pay off the hedges, Barrick will issue about 81.2 million shares at $36.95 per share. It will use $1.9 billion to eliminate all of its fixed-priced gold contracts within the next 12 months and another $1 billion to eliminate a portion of its floating spot price gold contracts…
Since Barrick announced their intentions, much has been written about the effect such an announcement might have, not only on Barrick’s share price going forward, but on the price of gold itself.
What has not been discussed in any meaningful manner is the very nature of gold hedges themselves.
When gold mining companies “hedge” future production, sovereign [read: Central Bank] physical gold bullion is sourced by and then sold through a “bullion bank.” The cash proceeds from the sale of physical bullion are then used by the mining concern to finance capital costs related to mine construction.
Interestingly, when Central Banks conduct these gold trades [replacing sovereign physical gold bullion for paper promises to repay] they continue to report – for accounting purposes – as if they still had clear title to the physical bullion.
The I.M.F. addressed this issue in Jan. 2007:
NEW ORLEANS, Jan. 22 /PRNewswire/ -- After months of inquiries and a hotly debated, in-depth position paper by its economic research unit, Blanchard and Company has learned that the International Monetary Fund has adopted a landmark accounting change to the way Central Banks account for their gold loans, giving this sector of the commodities market more transparency than it has ever had, the precious metals market leader announced today…
And here’s how the U.S. Treasury responded to the I.M.F. directive for increased transparency a few months later:
The US Treasury quietly made a subtle change [admitting that U.S. Sovereign Gold stocks included swaps] to its weekly reports of the US International Reserve Position, which includes the US Gold Reserve. This change was first made on May 14th. The differences can be seen by comparing the report’s old format release on May 8th to the new format used the following week. Here are the links:
http://www.treas.gov/press/releases/2007581342179779.htm http://www.treas.gov/press/releases/20075141738291821.htm
Quite a “landmark” admission, ehh? The shell game continues.
When Barrick Gold announced that they were eliminating their 9.5 million troy ounces of hedges, why isn’t anyone asking where Barrick is going to get the physical gold to do so?
9.5 million troy ounces = 295.48303 metric tonnes
The likelihood of 300 tonnes of Barrick’s existing production being diverted over the next 12 months is zero. We know this because of statements made by Barrick’s EVP, CFO, Jamie Sokalsky on their Q4/2008 earnings call on Feb. 20, 2009;
“... And so while we have allocated them [hedges] to the projects, they are still subject to the very strong, very favorable terms that we have negotiated in the past on these agreements. And so we do not have to start delivering. We have the ability to deliver any time within that largely ten-year time horizon for the bulk of the contracts. So it’s at our option within that time period under these committed agreements. Having said that, we’ve allocated them against the projects. And as those projects come into production, we’ve allocated them in the years from 2012 onward as the initial protection for our project financing that we are anticipating for that portfolio of projects."
From this, we can conclude what Barrick Gold is really up to: they are “immunizing their balance sheet” by purchasing gold futures [paper gold] to prevent further impairment of their financial position resulting from additional increases in the price of gold.
Perhaps this is why Barrick Gold’s announcement about the elimination of their gold hedges was so short of substance.
So who is left holding the bag? Great question; too bad no one in the mainstream financial press thought to investigate or inquire.
The answer, folks, is that sovereign assets [like TARP funds] are disappearing into the “ether” at alarming rates and the collective “WE” are being given little or no explanation as to the true extent of the paper games [or looting, perhaps?] being played at the U.S. Treasury.
Today’s Market
North American markets were mixed with the DOW losing 41.3 to 9,778.90, the NASDAQ gaining 5.18 to 2,138.04 and the S & P giving up 3.65 points to finish at 1,064.65. NYMEX crude oil futures dropped 2.56 to end the day at 69.48 per barrel. Japan's financial markets were closed today.
The benchmark 5 yr. government bond ended the day at 2.45% while the 10 yr. bond finished at 3.47%.
On foreign exchange markets the U.S. Dollar Index gained .29 to 76.73.
Precious metals were lower across the board with COMEX gold futures losing 3.30 to 1,004.20 per ounce while COMEX silver futures gave up .16 to finish at 16.86 per ounce. The XAU Index dropped 2.32 to 165.71 while the HUI Index fell 7.86 to 416.16.
On tap for tomorrow, at 10:00 a.m. July FHFA U.S. Housing Price Index data is due, expected .4% vs. prior .5%.
Wishing you all a pleasant evening!
Rob Kirby
Registered Representative
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