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According to an announcement dated September 8, 2009, Barrick is
going to throw into the dustbin its long-standing hedge policy, and pay for
buying back its hedge-book by diluting the value of its common stocks through
issuing more than 81 million new shares, or about 10 percent of the
outstanding. The so-called hedges of Barrick have been thoroughly discredited
and will soon be history. So-called, because the long-term forward sales
contracts in question that the parvenu gold miner has invented and flaunted
are not proper hedges and never have been. They are a fraud. They are naked
short positions pretending to be balanced by gold ore reserves in the moon
(or on this earth which, for hedging purposes, is practically the same
thing). Part of the newsworthy story, of course, is the fact that the hedge
book of Barrick has been increasingly under water for some nine years now,
threatening the unfriendly giant with drowning.
Within
24 hours another hasty announcement was made to the effect that the company,
instead of issuing 81 million new shares, will in fact issue 94.4 million,
that may be raised to 109 million if the demand justifies it, for a total
value of $4 billion — the biggest primary equity offering in Canadian
history according to the local media. The hike was explained by “strong
investor demand”. The market, however, put a big question mark to that
“forward-looking statement” of the company in marking down
Barrick shares 6.85% on the same day to $36.61, the greatest percentage loss
among the leading gold mining shares on the day. Incidentally, in doing this the
market has put a lower value on the Barrick stock than the company did.
Barrick is offering its new issue at the price of $36.95 per share.
The
$1.9 billion that Barrick is hoping to raise through this dilution maneuver
to eliminate all of its fixed-price gold contracts falls far short of its
goal of buying back its hedges. The liability represented by Barrick’s
once flaunted forward sale contracts has been carried off balance sheet so
far. These fixed-price gold contracts have a negative value of $5.6
billion, that will be charged to earnings in the third quarter. This negative
value will almost certainly increase during the next 12-month period Barrick
gave itself to get out of the quicksand. The announcement itself is a virtual
guarantee of that: Barrick will have to compete in the gold market with
China, Russia, India, Brazil, and other countries (not to mention other gold
mines in dire need to de-hedge) for a diminishing amount of gold available
for cash delivery, to the tune of 9.5 million ounces in today’s
strained gold markets.
The
big unknown question is whether Barrick will be able to buy back its hedges
fast enough to stop the continuing hemorrhage. Barrick is racing against the
clock. Gold is still available for cash delivery, but in what quantities? and
for how long? 9.5 million ounces is an awful lot of gold to buy in
today’s anemic gold markets with supplies drying up fast. With the
threat of the last contango and of permanent backwardation hanging overhead
like Damocles’ sword, Barrick’s plan appears to be a pipe dream
that will never be fulfilled. I may be in a minority of one on this one, but
Barrick’s future is anything but rosy. 9.5 million ounces is a lot more
gold than Barrick is able to produce in an entire year in the best of
circumstances. Even if Barrick were to sell not one ounce of gold in the open
market for a whole year, but deliver every ounce it extracts from the bowels
of the earth to its hedge books, and even if we accept the most optimistic
assumptions of the company to increase its annual production as realistic,
there is still a shortfall of at least 1.5 million ounces. I submit that
Barrick could not survive if it was to suspend its sales of new gold in the
open market for a whole year, while facing the extra cost of forcing up
production quotas. No lender in its right mind would finance such a crazy
plan. Creditors of Barrick would be all too happy to put the unfriendly giant
on the block, and sell Barrick’s stellar resources to the highest
bidders, who would be able to manage them in a saner and more responsible
manner than present managers have. Barrick’s managers were given the
right advice twelve years ago that, at the end of the road they have chosen,
lies ruin and misery. They had all the time to change course. But even at the
last major announcement on “hedging” in 2006, when Barrick
announced its new policy to lift a part of its hedges, the then CEO Greg
Wilkins said at the Annual Shareholders Meeting that Barrick will always
retain ‘a reasonable’ amount of hedges as an ‘essential
risk-management tool’. According to Wilkins, it is supposed to
‘stabilize’ revenues, and it is supposed to satisfy banks that
finance Barrick’s projects.
Two
years ago I issued a public challenge to the management of Barrick in my
piece “Have Gold Bugs Been Barricked by the U.S.?” (see
References below) as follows.
I demand an answer why Barrick ignored my recommendation in 1997
which I personally presented to the then CFO Jamie Sokalsky. During those ten
years my worst fears have materialized. It turned out that the
“hedging” policy of the company was, as I had stated, deeply
flawed. It was an unmitigated disaster of the first magnitude. It resulted in
horrendous losses to shareholders. It is not clear why Jamie Sokalsky, widely
rumored to be the author of Barrick’s “hedge plan”, got
rewarded with a promotion for executing a disastrous policy, and why his new
boss Greg Wilkins has stated in public that the company is standing by its
original hedging policy, albeit on a reduced scale. I categorically state
that Jamie Sokalsky had been thoroughly familiar with the alternative, what I
called the correct principles of hedging. He and I discussed the subject
together at great length, and he received from me a Memorandum that spelled
it all out. This Memorandum found its way into the book of the late Ferdinand
Lips entitled Gold Wars and can be seen there by any interested party.
I am disclosing it now for the first time that Barrick has
ignored my challenge. Yet, as its announcement of September 8 last proves, I
was right all along. The “hedging” policy of Barrick was so
obviously insane, so much in conflict with any common business sense, that it
invited extensive speculation that Barrick was not really a profit-seeking
business. It was just a front set up and operated by the U.S. (and/or by
other governments) in order to cap the gold price. In other words, Barrick
has been a partner to the greatest conspiracy in all history: to throw dust
into the eyes of the investing community making it believe the gold
demonetization fable. If the conspiracy theory is true, then the linchpin to
cap the gold price has been Barrick’s hedging policy. By aggressively
selling gold forward at the expense of the shareholders, the gold price could
be kept in perpetual check — or so the script went. Just make Barrick
the world’s Number One gold producer, its hedging policy will frighten
the daylight out of any bullish speculator in gold. And we might as well
admit that the conspiracy has been rather successful, in so far as
conspiracies can ever be successful.
In
the article quoted above I made it clear that I was not a subscriber to the
conspiracy theory, although I reserved my right to change this opinion
pending future evidence as they become available. A major piece of evidence
has just surfaced. Barrick has unceremoniously discarded its long-cherished
hedging policy, paying a heavy price in dragging the underwater hedges into
its badly punctured balance sheet that was no longer fooling anyone, and in
having to dilute the value of its outstanding shares.
Have
I changed my mind about the validity of the conspiracy theory? Is it not an
appealing interpretation that a decision made by policymakers in the U.S.
Treasury and the Federal Reserve deemed that the cost of maintaining the gold
cap at $1,000 is becoming too high? The cap can no longer be defended in view
of the world’s global credit crisis. Subsequently Barrick was to be
dumped and let to fend for itself in the rough waters after the sinking of
SS. Lehman. Barrick has received what it has so richly deserved: it has been
barricked by its partner in crime.
The
supreme irony of this scenario would be hard to escape. This would not be the
first time that a creature of Peter Munk has been barricked by a government.
There are some older guys around still, like myself, who remember how the
government of the Canadian province of Nova Scotia has barricked Munk’s
top line radio and hi-fi console manufacturing business. At that time Peter
Munk swore that he would never ever again accept a government subsidy, nor
would he participate in a conspiracy involving governments. It is all related
in Peter Munk’s approved biography in great detail (see References
below).
Every
business initiative of Peter Munk has ended as a fiasco and he went bankrupt
in consequence. After his radio and hi-fi business shipwrecked on the rocky
coast of Nova Scotia, his real estate enterprise in Egypt failed where he was
to build luxury hotels in the shadow of the great pyramids. His dabbling in
oil fared no better. Rumors have it that he also financed a franchise in
Israel of Colonel Sanders’ and his boys to make pork chops
“finger-lickin’ good” — that failed, too, although
this could not be confirmed.
After
an unbroken series of business failures Peter Munk has come to gold. Would
gold be kinder to him? There is hardly anybody alive who could appreciate
gold’s value better than he would. He owes his Holocaust survival to
gold that was paid by his father to Eichmann through Swiss intercession for
their free passage from Hungary to Switzerland in 1944. Yet there is probably
no one in the long line of failed gold mining executives who misconstrued gold
more thoroughly than Peter Munk has. Conspiracy or no conspiracy, Peter Munk
is an inveterate believer in the power of the U.S. government to manipulate
the price of gold. That is the secret of his downfall. Peter Munk’s
gold business is no better than his other businesses have been, only bigger.
I
am still not committed to the conspiracy theory according to which Barrick
has allowed itself to be used by policymakers in the U.S. to cap the price of
gold, although I must admit that the circumstantial evidence has become a
notch more circumstantial with this latest announcement. To me it looks like
the desperation of a passenger aboard the sinking Titanic who has lost his
life saver. I base my judgment on the timing. To make such an announcement at
a time when the gold price is challenging the $1000 level is a miscalculation
of Babelian proportions, not to say a suicidal dash to the exit. All this
time was wasted, while the gold price was under pressure, when exactly the
same announcement would have been helpful to Barrick — as it has to
Newmont. It is too late now. I do not see how Barrick can remain a viable
business entity once it has lost its tether, real or imagined, tying it to
the U.S. Treasury. My sympathy is with the shareholders of Barrick, who are
going to fare no better than those of Lehmann Brothers. What people do not
seem to understand is that gold locked up in ore is one thing, and gold
locked up in vaults is another. There are times, such as now, when their
values part company. Why? Because too many gold mines are just a conduit to
make the shareholder and his money part company. Remember Mark Twain having
said that a gold mine is a hole in the ground with a liar standing guard?
Remember Bre-X? It is so much easier to fool people than doing the
back-breaking work of bringing up gold locked in the ores deep underground.
Aaron
Regent, the new President and CEO of Barrick, commented on the
company’s announcement as follows:
“The gold hedge-book has been a particular concern among
our shareholders and the broader market which we believe has obscured the
many positive developments within the company. As a result of today’s
decision we have addressed that concern and maintained our financial
flexibility. With the industry’s largest production and reserves,
Barrick provides exceptional leverage to the gold price, which we expect will
be further enhanced as we build our new generation of low-cost mines.”
But leverage works both ways. In the case of Barrick it has
always worked the other way. Mr. Regent sounds as if the troubles of Barrick
were now over as management has finally decided to bite the bullet. They are
not. The agony will last until the last vestiges of the nightmare of “hedging”
will be erased. Even in the optimistic appraisal of management it will take
at least one year. In reality, it will take much longer, as ever higher gold
prices will frustrate efforts to close the hedge-book for once and all. The
fact is that the wolf is at the door and refuses to leave. The problem of the
hedge-book will keep resurfacing, until everybody will understand that it is
unmanageable. The cat is chasing its own tail.
The
job cut out for Barrick is the job of Sysiphus. He was a king who betrayed
Zeus’ secrets. As a punishment he was confined to Tartarus and made to
roll up a boulder to the top of the mountain only to see it falling back, and
his travail would start all over again.
When
everybody sees Barrick as the latter-day Sysiphus, the company will give up
the ghost, and the cheerful creditors will happily carve up the rich
caracass, with former shareholders looking on in dismay.
Antal
E. Fekete
San Francisco School
of Economics
aefekete@hotmail.com
Read
all the other articles written by Antal E. Fekete
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.
Copyright © 2002-2008 by Antal E. Fekete - All rights reserved
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