|
BARRICK
EXECS CONTINUE TO EXERCISE OPTIONS AND SELL SHARES
In Part Four I revealed that when it comes to
owning Barrick shares, the two top Barrick executives, CEO Greg Wilkins and
CFO Jamie Sokalsky have voted with their feet. In retrospect it looks more
like a stampede of insiders out of Barrick shares and options.
As
reported by the Canadian newspaper National Post on September 21 and 25,
Barrick executive vice president Alexander Davidson exercised 25,000 options
for company shares at $23.85 each on Sept. 18 and then sold these shares for
$39 each the same day. Davidson exercised 5,600 more options at the same
price on Sept. 20, then sold the shares. He exercised another 19,400 options
at the same price the following day, then sold the shares for $41 each.
Patrick
Carver, executive vice president and general counsel at Barrick exercised
12,100 options at $29.60 on Sept. 18, then sold these shares for prices
ranging from $39.35 to $39.41 the same day. He exercised another 12,000
options at $29.60 on Sept. 20, then sold these shares for $40.30 each the
same day.
Peter
Kniver, executive vice president and COO, exercised 40,000 options for
Barrick shares at $23.80 each on Sept.21, then sold these shares the same day
for prices ranging from $40.26 to $40.32.
Executive
vice president and CFO Jamie Sokalsky exercised 49,100 options at $30,70 each
on Sept. 19, then sold these shares the same day for prices ranging from
$39.45 to $39.61. This is in addition to selling 135,000 shares between Sept.
1 and 14 as mentioned in Part 4 of this series. Many others at Barrick have
exercised options and sold company shares. The National Post comments:
„Looking
for someone to pick up the tab for a night on town? Well, you might want to
track down
one of the 28 executives, directors and/or officers at Barrick who since
Sept. 1, 2007 have
exercised and sold more than 1.2 million options for company shares. Consider
the 420,050
options that were exercised and then sold in four days, from Sept. 10 to
Sept. 14. They
generated $3,254,651 plus $1,439,812 in total profits for the 15 Barrick
officers who performed
these transactions. That’s one helluva dinner for starters.”
More pertinently I ask the question: what’s the rush to get rid of
Barrick shares? What is it that insiders do know but shareholders may not?
Barrick
throws in the towel
It could have very well been the impending
bombshell timed to explode on September 28 when Barrick CEO Greg Wilkins was
to announce that the company „has no plans to return to the futures
markets to hedge its gold production”. This amazing announcement is in
my opinion nothing short of an admission of guilt. Barrick’s hedging
policy has caused a financial disaster that was perfectly foreseeable and
avoidable. Barrick executives have been warned that their so-called
hedge-plan was fraudulent and involved the company with unacceptable risks. I
told CFO Sokalsky in person about the errors of his ways already ten years
ago. My 50-page memorandum Gold Mining
and Hedging — Will hedging kill the goose laying the golden egg? that
I prepared for Barrick executives is in the public domain. Ferdinand Lips in
his book Gold Wars quotes
extensively from it.
Shareholders
would be perfectly justified in launching class action suits against Barrick
executives. Insiders are well aware of this. Hence the spectacular stampede
to dump Barrick shares that may have their origin in illegally paid bonuses.
Why, these bonuses could possibly represent paper profits rather than earned
profits. It is criminally fraudulent to pay yourself a bonus out of paper
profits. The contingent liability encumbering paper profits could turn into
real losses for which the funds paid out in bonuses should have served as cover.
Apparently this is what happened to Barrick: the rising gold price made paper
profits from Barrick’s „hedges” evaporate while turning all
remaining „hedges” into a loss-maker. Millions of dollars that
Barrick executives have recently pocketed from bonuses could conceivably be
part of the cover for losses embodied by the 9½ million ounces of
„hedges” under water.
It
is remarkable and noteworthy that CFO Sokalsky has got off from his high
horse. He is no longer touting his so-called hedge plan that involved using
paper profits for the purposes of window-dressing operational profits. Quite
possibly company counsels have warned him that such a tactic may be deemed
illegal and actionable by shareholders.
As
reported by Reuters quoting an interview on CNBC, on Friday, September 28
company president Wilkins announced the end of the saga of
„hedging” in gold mining. He still appeared to be defending the
practice by promising that the company is going to continue to hedge its
copper production. The red herring of copper hedging will lull nobody into
believing that the discontinued gold hedging strategy was unobjectionable
from the legal point of view. The objection is not against the use of the futures markets in hedging; it is
against the practice of selling leased
metal. There is no lease market for copper so Barrick cannot sell leased
copper.
As
this series Peak Gold!, a primer on
the economics of gold mining, has set out to show, the economics of copper
mining is as different from that of gold mining as night is different from
day, on account of the different behavior of the underlying marginal
utilities (see below).
Be
that as it may, Barrick has thrown in the towel. Truth has won over
falsehood. President Wilkins said in the interview: „Frankly, our
investors are really looking to benefit from the upside of gold and we share
that point of view.” He did not explain why it took him so long to come
around to honoring the wishes of shareholders, nor did he say what other
criteria than serving the interest of shareholders may guide his actions.
Deafening silence surrounds the question what he is planning to do with the
9½ million ounces worth of „hedges”, now deeply under
water as a direct result of the foolish hedging policies of management, and a
potential source of further horrendous losses in case the price of gold
advances further.
The
fact is that Barrick is haemorrhaging gold, and the executives are trying to
cover it up. Rome is burning and Nero fiddles on the roof. A few days
earlier, at the Denver Gold Group Forum, Wilkins talked to the assembled
mining experts complaining about the high price of truck tires explaining how
he was going to fix the problem. Not one word was said about the 9½
million ounces of „hedges” under water, or how they can be lifted
before they do further damage to the company and its shareholders. The CEO
talks about building a truck tire factory when the gold mine is on fire. Perhaps,
if he put out the fire first, then he could afford to pay the going price for
truck tires.
Of
course, he must have noted that „hedging was practically
anathema” at the Forum, as niftily put by Citigroup analyst John Hill.
Was Wilkins just trying to be considerate in avoiding an unpleasant subject?
The gold price reacted to the news that Barrick has thrown in the towel by
jumping almost $10 to $744, a 28-year high. That cost the company and its
shareholders a cool 95 million dollars.
Still,
Barrick shareholders have every reason to celebrate. I take this opportunity
to congratulate them upon their victory over a fossilized management. I
pledge my further support to them with my pen. I shall provide a post mortem on Barrick’s
unilateral hedging strategy. I have changed the subtitle of this series to: A Primer on the Economics of Gold Mining,
to indicate that a new era has started in the history of gold mining. The
mindless rush of gold mining companies to play „follow the
leader” is over. I could not find anybody willing to defend
Barrick’s indefensible strategy of unilateral hedging. This strategy
has been thrown where it belongs: to the garbage dump of history. Make no
mistake about it: this was the greatest
mining disaster in the history of gold mining.
Two-legged
straddles
I shall now explain what Barrick has done wrong,
and how it should have proceeded instead. What I have to say is basically no
different from what I told Sokalsky ten years ago. Selling gold futures at
price spikes in excess of annual output is not hedging, it is naked forward
selling. As events have proved, I was right: naked short selling is a foolish
strategy as it can make even the #1 gold miner suffer, not just a loss of
face, but also the loss of billions of dollars.
Consider
two hypothetical gold mines, AXY and XAB. Compare their operations which are
very similar yet fundamentally different. Both mines work with two-legged
straddles having a short and a long leg. With their short legs they both
enter the gold futures market. The difference is in where they put the long
leg. I wish to emphasise that this example is schematic, that is,
oversimplified for easier comprehension. The actual situation is considerably
more complicated, but simplifying it does not affect the underlying
principle. AXY enters the long leg of its straddle into the bond market; XAB
keeps the long leg anchored in the gold mine itself.
From
this it should already be clear that XAB’s are true hedges in the sense
that they are rooted in mining. By contrast, AXY’s hedges are false.
The gold mine has been turned into a hedge fund. At any rate, its
„hedges” have nothing to do with gold production. AXY needs gold
only as a source of cheap financing for its gambling ventures.
Fraudulent
hedging
Suppose there is a $10 upwards spike in the gold
price. AXY reacts by selling 100 gold futures contracts. In doing so it locks
in a selling price for gold, gold that it arranges to borrow from a bullion
bank at 1 percent per annum interest, in order to sell it and invest the
proceeds at 6 percent in the bond market for a net income of 5 percent per annum. AXY does not
think that it is in any danger on account of a possible advance in the gold
price. „What goes up must come down”. In any case it reasons that
the gold sold forward is in hand: it can be scooped up from its mines at any
time. But as we have seen in Part Three, this is a fundamental mistake. AXY
does not have the gold in hand: it only has a bird in the bush. The hedge is
fraudulent because the 5 percent net interest income is commingled with
operative profits, disregarding the contingent liability that AXY still has
on its open „hedges”. As we have observed, it is criminally
fraudulent to represent paper profits as earned profits.
True
hedging
The other gold mine XAB reacts the same way to
the initial $10 upwards spike in the gold price: it also sells 100 contracts
of gold futures, the short leg of the straddle. The difference, as already
suggested, is in the long leg which in this case is entered into the actual
production of gold from the mine.
In
more details, XAB is alive to the opportunity offered by the fact that the upward spike in the gold price has
promoted some of its submarginal grades of ore into the payable category.
To fix our ideas suppose that XAB has a submarginal vein of gold bearing ore
it affectionately calls Moonbeam. Even though submarginal, Moonbeam it is not
barren. It is pregnant with profits which XAB wants to capture.
A
godsend, XAB finds that Moonbeam is now payable, thanks to the $10 upwards
spike in the gold price. The trouble is that the godsend may be available
only for a couple of minutes, and it is not possible to get the gold out of
the ore and take it to the market in such a short space of time. No problem.
That is where hedging, in the true meaning of the word, comes in. Using
the facility offered by the gold futures market XAB can lock in the spiking
price now; mine and deliver the gold later. Geologists at XAB know exactly
how much of Moonbeam ore should be earmarked and mined in order to come up
with the right amount of gold that must match the amount sold forward. The
mine goes ahead and produces the gold. Never mind if the price of gold has
fallen back in the meantime. The higher selling price is locked in. When the
gold produced from Moonbeam ore is sold, the mine lifts its hedges, i.e.,
covers the short position in the futures market.
In
effect, XAB has sold gold at a profit from ore that, absent hedging,
represents zero value. It looks like prestidigitation, but it isn’t. It
is the same idea as harnessing energy from the tide-and-ebb movement of the
oceans. XAB harnesses the fluctuating gold price which represents energy. The
energy of tides, given the skill of engineers, can be put to use. Likewise,
the skilled gold miner can squeeze gold out of worthless rock. That’s
the challenge of the profession, challenge that not every gold miner can meet.
Notice
that XAB does not care if the price of gold has increased between its selling
of gold futures, and its selling cash gold later. It is true that any
increase generates a loss on the short leg, but it is compensated dollar for
dollar by the higher price it will receive for the gold extracted from
Moonbeam. XAB only cares about the opportunity of selling gold profitably,
gold, the production of which in the absence of hedging would involve the
mine with a loss. If, on the other hand, the gold price fell back, then the
short position of XAB in the gold futures market would show a profit. That profit
could be taken immediately.
Suppose
that the chance of the gold price moving up or down after every $10 spike is
50-50. Then the mine will enjoy an extra
income from its hedging operations because 50 percent of its hedges will
be closed out profitably without even
touching any gold bearing ore. The other 50 percent is just as beneficial
making it possible to extract gold profitably from submarginal grades of ore.
Herein you have a win-win strategy. Quite unlike Barrick’s which is a
lose-lose strategy — except in a bear market for gold.
Fool’s
gold future
This being a post
mortem I want to explain most carefully what has made the boat of Barrick
hit reef. The #1 gold miner did not understand the subtle difference between
selling gold futures and selling borrowed gold. While both come under the
heading „selling gold forward”, there is an important difference.
The gold mine selling gold futures has
not sold the gold, so any possible mis-judgement in timing is
self-correcting. On the other hand, the gold mine selling borrowed gold has
thereby finalized the terms of the sale. Only delivery is put off. The
self-correcting feature is missing. Any error in timing could be disastrous.
Barrick
is totally ignorant of (true) hedging. Observe the difference between two
operations: (1) Selling gold futures for hedging purposes is one thing. It
simply means booking a selling price now, with the actual sale of newly mined
gold to follow later. A subsequent increase in the price of gold is not
hurting because the gold mine has retained the right to sell gold at the
higher price later.
(2) Selling borrowed gold is another thing
altogether. The actual sale of newly mined gold at a fixed price has been
consummated, only delivery remains. Every cent of an increase in the price of
gold is hurting because the increase means that the gold has been sold at the
wrong price.
AXY
acts as a hedge fund. Its straddles are fraudulent. Even if the financial results
are positive in the end, it cannot report, still less pay out, a profit.
Profits are paper profits. They will not be finalized until the
„hedges” are lifted. There is a contingent liability which can
turn into real losses if the gold price has a subsequent run on the upside.
Paying out paper profits in bonus is a criminal fraud. The fact that AXY is a
gold mine has nothing to do with its adventures in the world of gambling. Any
hedge fund can do it (and will probably do a better job of it). The problem
plaguing Barrick now is that it has commingled paper profits from gold and
bond speculation with operating profits from gold mining and has, apparently,
dipped into its treasury and paid hefty bonuses to executives and directors.
The money is gone, but the contingent liability remains. When the gold price
increases, it becomes a loss that
gets larger with every cent of an increase in the gold price. The
potential loss is open-ended.
Double
jeopardy
No wonder that the 28 Barrick executives are in such
a mad hurry to cut and run before their bonuses are attached by court
injunction in a possible class action suit. Damn whoever invented bonuses in
the form of options. Cash bonuses would not have left such a stinking paper
trail.
By
contrast, consider XAB. It acts as any proper hedger does who is involved in
the production of real goods. Its straddles are true hedges: they aim at
benefiting the company from favorable price hikes by producing gold from ore
body whose market value is zero in the absence of a hedging strategy. This
operation is completely independent of the fickleness of interest rates and
of the variation of the gold price.
Note
that the profitability of the „hedges” of AXY is exposed to
„double jeopardy”. It depends on the assumption that neither
interest rates nor the gold price will rise. Should either do, the
„hedges” will show an immediate loss. Higher interest rates make
the market value of bonds fall, hurting the long leg of the straddle. A
higher gold price will increase the cost of lifting the straddle.
Maximizing
the life of the gold mine
But the main difference between the two
strategies has to do with the fact that true hedging (the strategy of XAB)
extends the working life of the gold mine, while fraudulent hedging (the
strategy of AXY) shortens it. True hedging spares the richest ore bodies and
shifts mining towards the submarginal grades or ore. This also means the most
efficient deployment of the capital of the mine.
Barrick-type
hedges result in a ruthless exploitation of the mining resource. Naturally,
AXY wants to squeeze the maximum amount of cash out of its
„hedges”, regardless of the damage it may cause to the logevity
of the mine, because it wants to buy as many bonds as possible. In consequence
the richest grades of ore are extracted first and the mine is exhausted
prematurely. When it is forced to close down, it will still have a lot of
valuable gold-bearing ore left behind.
Economics
of Gold Mining
The economics of gold mining is as different from
that of base metal mining as day from night. The aim of a copper mine, for
example, is to maximize profits without regard for the working life of the
mine. The reason is that the marginal utility of copper is declining. This
means that if you do not market your copper at the earliest opportunity, then
competition grabs your market share and runs with it. Tarda venientibus ossa —
says the Latin proverb (late-comers to the meal get the bones). In the
case of copper miners late-comers have to sell at a lower price.
By
contrast, the marginal utility of gold is declining so slowly that it is
practically constant. There is no pressure on the miner to rush his product
to the market. His concern is to get as much gold throughout the mine’s
extended working life as possible, regardless how long it may take. If it
takes longer, no harm done. The mine stands to benefit from deliberate
currency debasement practiced by governments. Debasement has the unintended
effect of promoting the submarginal ore bodies of the gold mines to the
payable category.
Incidentally,
this is the secret of the popularity of owning gold mining shares in spite of
the meager returns to invested capital. Gold mining shares have a built-in
option-feature. The option expires when the gold mine is exhausted. Thus
given two identical gold mines with exactly the same geological features, the
one worked more conservatively will command the higher share price and the
higher market capitalization, because the underlying option has the longer
maturity date. The market will assign the lowest market capitalizartion to
the gold mines that go after the highest grade of ore, even if the dividends
paid by that mine are higher.
Having
said that, we find that the hedging stategy of XAB still has shortcomings and
calls for further improvements. Both AXY and XAB are using unilateral hedging
strategies. As a side-effect speculators are invited to converge on the short
side of the market and compete with the gold mines to nip every gold rally in
the bud. What is needed, clearly, is bilateral hedging and its four-legged
straddles to eliminate that threat. This is the subject of the next
instalment of Peak Gold!.
GOLD
STANDARD UNIVERSITY LIVE
Session Three of Gold Standard University Live
will take place in Dallas, Texas, from February 11 through 17, 2008 (please
note the change of place and date.) It will have three parts:
(1) a course on Adam
Smith’s
Real Bill Doctrine and its Relevance Today, consisting of 13 lectures,
from February 11 through 14;
(2) a debate on the Economics of Gold Mining with industry participation;
(3) a panel discussion entitled Gold Profits in Troubled Times where
paraphernalia such as the basis, the gold and silver lease rate, the NAV of
gold and silver ETF’s and the variation of these will be discussed with
invited experts. Program (2) and (3) are scheduled for the week-end February
15-17. The registration fee covers participation in the debates during the
week-end. It is also possible to register for the week-end program only at a
reduced fee. Participation is limited; first come first served. Participants
pay their own hotel and meal bills. The cost of the closing banquet is
included in the registration fee.
For
the benefit of European friends of Gold Standard University, Session Three,
will be repeated in March, 2008, at Martineum Academy in Szombathely,
Hungary, where the first two sessions were held, provided that a sufficient number of people register. More
details will follow later.
For
further information please inquire at GSUL@t-online.hu.
References
A.E. Fekete, Peak
Gold!, August 15, September 10, 19, 26, 2007
A.E. Fekete, Have
Gold Bugs Been Barricked by the U.S.?,
July 12, 2007
A.E. Fekete, Gold
Vanishing Into Private Hoards, , May 31, 2007
A.E. Fekete, To
Barrick Or To Be Barricked, That Is the Question,
August
11, 2006
A. E. Fekete, The
Texas Hedges of Barrick, www.goldisfreedom.com,
May, 2002
Charles Davis, So Big It’s Brutal, Report on Business, The Globe and Mail:
Toronto, June 2006, p 64.
Bob Landis, Readings
from the Book of Barrick: A Goldbug Ponders the Unthinkable, www.goldensextant.com , May 21, 2002
Richard Rohmer, Golden Phoenix: The Biography of Peter Munk, Key Porter Books,
1999
Ferdinand Lips, Gold Wars, Will Hedging Kill the Goose Laying the Golden Egg? p
161-167,
New
York: FAME,
George
Bush’s „Heart of Darkness” — Mineral Control of
Africa, Executive Intelligence Review, January
3, 1997, see in particular:
Barrick’s
Barracudas
Inside
Story: The Bush Gang and Barrick,
by Anton Chaitkin
George
Bush’s 10 billion giveaway to Barrick, by Kark Sonnenblick
Bush
abets Barrick’s Golddigging, by Gail Billington
See
also: http://american_almanac.tripod.com/bushgold.htm
DISCLAIMER AND CONFLICTS
THE PUBLICATION OF THIS ARTICLE IS SOLELY
FOR YOUR INFORMATION AND ENTERTAINMENT. 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. HE HAS NO
POSITION, LONG OR SHORT, IN BARRICK STOCK, NOR DOES HE INTEND TO ACQUIRE ONE.
THE CONTENT OF THIS ARTICLE 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.
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.
| 
