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Part One
Antal E. Fekete
Gold
Standard University
Live
Introduction
Gold mining
executives would like to forget the hedging fiasco as you would the worst
nightmare of your life. But the ghost of this greatest shareholder rip-off will
not let them. It keeps haunting them, and for a very good reason, too. There
are still more skeletons in the cupboard. Just take a look at gold mining
share prices and their reaction, or rather the lack of it, to the unfolding
banking crisis. They eloquently tell a tale of deep distrust in the veracity
and competence of gold mining executives. This is an industry that is totally
incapable of analyzing and admitting past mistakes, let alone learning from
them. The full extent of the fiasco will not be known for many more years
because we don’t know how high the gold price will go in the wake of
the banking crisis. What is clear already is the disconnect
between gold and gold mining shares. It will remain as long as the industry
fails to get its past and present sins off its chest and reform itself.
According to a Hungarian proverb, dead
fish stink because of the head. This can be readily applied to the gold
mining industry which obviously stinks. Senior gold producers pretend that it
is business as usual. It is not. The same executives responsible
for the rip-off are still in charge. They are not trusted, and they are not
to be trusted. The hedging fiasco was bad because it accelerated the aging
process of producing gold mines. It was an appalling case of wasteful exploitation
of a world resource. It was a case of robbing shareholders. Forward selling may be gone, but
wasteful exploitation is still very much with us. It will be, until a new
generation of managers is brought in to initiate a new program of forward buying. This means that at
every major decline in the gold price (such as the present one, for example),
the gold mines should step into the breach and buy gold forward with the same
élan as they were selling it
short under their hare-brained scheme of hedging. This strategy would
accomplish three things: (1) it would slow down the aging process of their
producing gold properties; (2) it would facilitate locking in a good price
for new gold properties the purchase of which the management may be in the
process of negotiating; (3) it would be the first step in replacing the
obsolete marketing model of selling output hot from the mine, by the
up-to-date marketing model of trading
the basis.
Hedging or
speculation?
If the gold
mining industry is reluctant to draw the balance sheet of its adventures in
hedging, we shall be happy to do it for them. Hedging was a conspiracy to rob
shareholders of their most durable long-term asset: gold locked up in ore
deposits. It was a design to dissipate those assets in aid of government
profligacy. Nor is it over yet. As the unresponsiveness of the share price to
the banking crisis demonstrates, shareholders are still unconvinced.
The
rest of this article is an excerpt (slightly edited) from the late Ferdinand
Lips’ book Gold Wars
published in 2002 by FAME (www.fame.org),
p 160-167.
„A
closer look at hedging reveals that, in many cases, it has turned into
outright speculation. Professor Fekete describes these practices as follows.
„The Hedging Revolution started
in 1985. Barrick Gold (then called American Barrick) was one of the pioneers. Hedging looked like a
brilliant idea when it was first conceived at Barrick.
It put the gold mining industry in a category by itself as the only segment
of the economy that could pull itself out of the debt-morass by its own
bootstraps.
Barrick’s
hedging policy as described in the company’s annual reports (see in
particular those for 1994, 1995 and 1996) is not, strictly speaking, an exercise
in hedging, but an exercise in speculation. Barrick
is betting that the gold price will never again be able to repeat the feat it
has performed several times since 1968, namely to break out on the upside,
never again to fall back to those old levels. Should it try, Barrick and others stand ready, and would promptly club
it down with their persistent short selling. This was a revolution indeed.
The gold miner cut a strange figure, showing him as gold’s worst enemy
second only to the government. He made every budding rally abort through
unilateral hedging. The result of Barrick’s
innovation was competitive, industry-wide short selling. This was most
demoralizing to the market, certainly on the supply side but no less on the
demand side. It has turned the industry into a bunch of cannibals: everybody
wanted to sell before everybody else. But it was even more demoralizing to
potential buyers and all long-term holders of gold. The market perception was
that the industry was being led down the primrose path to ruin. While selling
gold short, these so-called hedgers were ultimately ruining their own market.
They would kill the upside potential. They
would kill the goose that was to lay the golden egg.
Even more ominously, there was also a bearish element in the picture.
The powerful speculative following of the gold market, traditionally bullish,
was alienated en bloc. They were
chased away from the long end of the market to join Barrick
on the short.
From Barrick’s own point of view,
unilateral short selling appears to be a short-sighted and, in the long run, self-destructing strategy. It throws all conservative
principles to the winds in an aggressive pursuit of short-term profitability.
Whatever the short-term benefits may have been, the strategy ultimately
shortened the working life of Barrick’s gold
properties, hurting shareholders. Barrick had to
close down operations at five of its ten working sites as they became
’mined out’ ― not through extraction but through
evaporating payable ore reserves. It is
for the first time in history that productive gold mines were forced to close
down ― not through attrition but because the falling gold price was
wiping out big chunks of payable grades of ore. These mine closures
reflect a colossal destruction of capital represented by abandoned milling
plants and other mining equipment. Nobody could predict the fiasco ―
least of all the officers of Barrick. How could it
happen? Observers stress the fact that while there is a physical limit on the
production of cash gold, namely, milling capacity, there is no limit on the
’production’ of futures contracts, or paper gold, if its maturity
dates are being pushed ever farther out into the future. Barrick’s
anti-conservationist mining practices and aggressive short sales were the
flip-side of the inundation of the market with unlimited amounts of paper
gold.”
Barrick’s
cost of production from top grades may well be reduced to $150 per ounce, as
boasted by management ― but how long will these top grades last? In Fekete’s view the only solution to the dilemma is bilateral hedging. The strategy of
forward sales must be complemented with a strategy of forward purchases. As
it is, every rise in the price of gold is countered by forward sales ―
but nothing is done to counter a fall! Properly understood, neither forward
sales nor forward purchases need to involve speculation, but are what they
are: true hedging in the interest
of the company and its shareholders.
Unmitigated
fraud
In the fall of 2000
I asked Professor Fekete whether he has revised his position regarding Barrick. He said that he has not changed his mind at all;
quite the contrary.
„You
should bring in the very serious charge that Barrick
knowingly misleads shareholders, creditors, and the general public. For
several years in a row, in its Annual Reports, at its shareholders meetings,
press conferences, Barrick has been reporting
consistently higher profits, attributed to its mythical ability to realize
higher prices for its newly mined gold than prices bid in the market during
the entire year in question. These reports of higher profits have been duly
certified by reputable accounting firms, and they have never been questioned
by academia, let alone the financial press.
We
all kow what academia and the financial press would
say if a company with publicly traded shares announced that it was
manufacturing and marketing the 21st century version of perpetuum mobile.
Barrick boasts that it could accomplish the miracle of
consistently selling gold at a price higher than the market has ever bid
during the entire year through its ’sophisticated tool of
hedging’.
Here
is a sophisticated question I want to address to Barrick:
„Why not share this ’secret’ with the American farmer?
Would it not be wonderful if they, too, could consistently realize higher
wheat prices than the market is willing to bid? Where are the farmers
organizations to demand that they be told the secret of turning the stone
into bread?
Well,
Barrick could not share its secret with anybody
because the ’miracle’ can only be performed through fraud. If we
wanted to be charitable, we would assume that the accounting firms did not
understand what they were certifying. Otherwise they would not lend their
good name to this chicanery aiming at misleading the public. It is hard to
escape the suspicion that the accounting profession may be an accomplice in
this conspiracy to defraud.
It is not, has never been, and will never
be possible to sell gold forward consistently at a higher price than the
highest price bid by the markets during the year under review, any more than
it is possible to turn lead into gold profitably.
Here
is what Barrick is doing. It sells gold borrowed at
the low lease rate, and invests the proceeds into high-yielding U.S. Treasury
paper. Then it recalculates its revenues boosted by the positive spread
between the yield on Treasury paper and the gold lease rate, and reports its
profits as if it had been earned through consistently reaping a higher price
for its gold than that quoted by the market.
Why is this procedure an unmitigated
fraud? Apart from reporting profits under false pretenses, observe the
fact that the transaction remains incomplete. Profits are merely ’paper
profits’ as long as all deals have not been closed out and borrowed
gold returned to the owners. It may not
be possible to realize those paper profits, ever. It is quite conceivable that these forward commitments can
only be closed out at hideous losses. For such a scenario, nothing more
drastic need to happen than for the price of gold to return to a higher level
where it has already traded for years or decades.
Barrick is speculating: it assumes that ’what goes
up must come down’. If the gold price goes up, say, $200 per ounce,
then it is duty-bound to come down at least that much in due course. Those
with financial staying power (such as Barrick
considers itself to possess in good measure) will be able to ride out any
storm caused by temporary spikes in the gold price. Barrick
lives in a fools’ paradise thinking that it can roll over all futures
contracts showing a loss, several times if necessary, until the gold price
comes down again and the commitment can be covered at a profit.
Double standards
The
truth remains, however, that all Barrick has
accomplished was to sweep margin calls on its short positions of gold under
the rug, thus concealing the potential liability from its shareholders and
creditors. Therein lies the fraud which accountants should point out, and if
they fail to do so, the SEC should uncover, expose, and prosecute. Instead,
they adopt the ’hear no evil, see no evil’ attitude.
Barrick wasn’t around in 1968. But suppose for the
sake of argument that it was. Assume further that Barrick
had sold borrowed gold at $38 per ounce (which may have appeared an
incredibly smart thing to do at the time) In that case Barrick
would, a third of a century later, still be rolling over its gold loans in
the forlorn hope that the gold price would be good enough to drop below $38
in order to enable Barrick to unwind its losing
position with a profit. In fact, after 1968, the year the U.S. Treasury
defaulted on its obligation to pay foreign creditors, as contracted, in gold
at $35 an ounce, the price of gold took off never to come back again. Barrick could still be holding the bag, a bag of losses,
and keep reporting huge profits, because the conspiring bullion banks allow
it to roll over its losing short position on gold sold at $38 an ounce. (It
may be worth pointing out that today the position of the US Treasury vis-à-vis its foreign creditors
is far worse than it was in 1968.)
It has happened any number of times in
history that the gold price took off never ever again to come back to the
level it has started from. For this reason, any accounting assumption
that a commitment to deliver gold at a future date can be closed out
profitably if one is willing and able to wait long enough, is simply
fraudulent. It should never be allowed
in a society with self-respecting legislators making meaningful contract
laws. And the fraud should be exposed by self-respecting accountants and
other watchdogs of fair play.
Just
as grain-elevator operators are not allowed to calculate and report profits
derived from forward sales of wheat several years into the future in the same
way as they calculate and report profits on the sale of wheat physically
present in their elevators, gold mines should not be allowed to calculate and
report profits on the forward sale of borrowed gold in the same way as they
calculate and report profits on the sale of newly mined gold from their
mines. There is a contingent liability on the short positions. Until and
unless they are closed out there is no
profit to report. As the proverb says, ’there’s many a slip
between cup and lip’.
It
is disgraceful that public prosecutors allow this double standard to prevail.
What is rightfully prohibited to grain elevators should not be permitted to
gold mines. It is to the eternal shame
of our civilization that it allows this unsavory conspiracy between the
banks, the gold mines, and the government (with the accounting profession,
academia, and the financial press looking on) to defraud the general public
through the hocus-pocus of ’hedging’ and forward selling.”
* * *
This
was written in 2000. Writing in 2008 I can add that the worst-case scenario
eventually caught up with Barrick. The gold price
has been increasing so much and so fast that Barrick
was unable to lift its short positions in an orderly manner. Most of it is
still on. The company’s finances still sag under the burden of selling
gold short at $300 and below. The president of the company had to eat his
words that ’forward selling will always play a role in the marketing
strategy of Barrick.’ Barrick
did not sell as much as one ounce of gold short at $1040 last April.
The
company is trying to camouflage the financial mayhem by charging all its
losses to just one producing unit and feature the remaining ones as
hedge-free. But can shuffling really eliminate the bad card from the deck?
The company is still hemorrhaging gold, and a better policy would be to close
the hedge book and burn it for good.
In
the second part of this article I will explain that the marketing strategy of
Barrick to sell newly mined hot from the shaft is
obsolete and wasteful. It is a pig-headed and ham-handed approach in view of
the fact that a more efficient modern marketing strategy is available. Barrick should stop
selling the gold price and start
selling the gold basis.
Calendar of events
New York City, October 16,
2008
Committee for Monetary Research and Education, Inc.,
Annual Fall Dinner.
Professor
Fekete is an invited speaker. The title of his talk is:
The Mechanism of Capital Destruction.
Inquiries: cmre@bellsouth.net
Santa Clara, California,
November 3, 2008
Santa Clara University, hosted by the Civil Society Institute
Professor Fekete
is the invited speaker. The title of his talk is:
Monetary Reform: Gold and
Bills of Exchange.
Inquiries: ffoldvary@scu.edu
San Francisco, California,
November 4, 2008
Economic Club of San Francisco
Professor
Fekete is the invited speaker. The title of his talk is:
The Revisionist Theory and History of the Great Depression ― Can
It Happen Again?
Inquiries: ifkbischoff@yahoo.com
Canberra, Australia, November 11-14, 2008
Gold Standard University Live, Session Five.
(This is the last session of GSUL since our sponsor, Mr. Eric Sprott of Sprott Asset
Management, Inc., has withdrawn his support saying that in his opinion the
results do not justify the expenditure. Come along and judge for yourself.)
This 4-day seminar is a Primer on the
Gold Basis ― A Most Important Trading Tool, Mining Tool, and Early
Warning System. Inquiries: www.feketeaustralia.com.
A more detailed description of this seminar is found at the end of my article
Cut Off Your Tail to Save My Face! September 1, www.professorfekete.com
Antal E. Fekete
Professor, Intermountain
Institute of Science and Applied Mathematics, Missoula, MT 59806, U.S.A.
Gold Standard University
aefekete@hotmail.com
Professor Antal E. Fekete was born and educated in Hungary. He immigrated to Canada in 1956. In addition to
teaching in Canada, he worked in the Washington DC office of Congressman W.
E. Dannemeyer for five years on monetary and fiscal
reform till 1990. He taught as visiting professor of economics at the
Francisco Marroquin University in Guatemala City in
1996. Since 2001 he has been consulting professor at Sapientia
University, Cluj-Napoca, Romania. In 1996 Professor Fekete won the first
prize in the International Currency Essay contest sponsored by Bank Lips Ltd.
of Switzerland. He also runs the Gold Standard
University.
Copyright © 2008
A. E. Fekete
All rights reserved
DISCLAIMER AND CONFLICTS
DISCLAIMER AND CONFLICTS
THE PUBLICATION OF THIS LETTER IS FOR YOUR INFORMATION AND AMUSEMENT ONLY.
THE AUTHOR IS NOT SOLICITING ANY ACTION BASED UPON IT, NOR IS HE SUGGESTING
THAT IT REPRESENTS, UNDER ANY CIRCUMSTANCES, A RECOMMENDATION TO BUY OR SELL
ANY SECURITY. THE CONTENT OF THIS LETTER IS DERIVED FROM INFORMATION AND
SOURCES BELIEVED TO BE RELIABLE, BUT THE AUTHOR MAKES NO REPRESENTATION THAT
IT IS COMPLETE OR ERROR-FREE, AND IT SHOULD NOT BE RELIED UPON AS SUCH. IT IS
TO BE TAKEN AS THE AUTHORS OPINION AS SHAPED BY HIS EXPERIENCE, RATHER THAN A
STATEMENT OF FACTS. THE AUTHOR MAY HAVE INVESTMENT POSITIONS, LONG OR SHORT,
IN ANY SECURITIES MENTIONED, WHICH MAY BE CHANGED AT ANY TIME FOR ANY REASON.
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