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"A
hedged gold mine is a hole in the ground with a liar standing next to
it"
(With apologies to Mark Twain for refining his aphorism)
Putting the cart before the horse
As discussed in
Part One, a most unusual conference call took place on August 3 last. Barrick President Greg Wilkins and Executive Vice
President and CFO Jamie Sokalsky officially
proclaimed Peak Gold! by disclosing that
according to research commissioned by the company world gold production has
peaked and will decline from now on. They suggested that we might expect a 10
to 15% drop in overall mine supply of gold within the next five to seven
years, with obvious positive implications for the gold price. This was widely
reported in the financial press.
What makes the
announcement highly unusual, not to say suspect, is the fact that
industry-leader Barrick still has 9,5 million gold ounces worth of open hedges and will
suffer accordingly in the rising-price environment. It is just not logical,
and even appears masochistic, to make such an upbeat announcement about the
gold price first, and lift the hedges afterwards (as it is the
destiny of all hedges to be lifted ultimately).
Since the
company was in possession of such an explosive
information impacting the gold price, the logical procedure should have been
to lift the hedges first, and to release the report afterwards. The
reverse-order procedure could hurt the company financially, hurting
shareholders even more. Could it be that the top brass of the company has a
hidden agenda and treats shareholders as dummies who do not understand the negative
impact on the hedge book of a positive spin on the gold price by
putting it even deeper under water?
Captain and mate, first in the life boat
Well, we did
not have to wait too long for the solution to the puzzle. On September 9
President Greg Wilkins exercised 100,000 options for company shares at $27.30
each and sold all these shares the same day at prices ranging from $38.30 to
$38.80. Next day, on September 10, executive vice president and chief
financial officer Jamie Sokalsky turned up, and
exercised 35,000 options for company shares at $23.80 each. Then, between
September 10 and 14, he exercised 90,900 more options for company shares at
prices ranging from $29.20 to $30.70 each. He sold all these shares the same
day at prices ranging from $36.70 to $36.74, thereby reducing his total
company holdings to zero. Total company holdings of president Wilkins was
brought back to the original 47,500 shares ? according to the Canadian newspaper National Post,
September 17 and 18, 2007. After all, it is fitting that the president of a company own at least a few shares in the
company, however reluctantly.
It is hard to
escape the conclusion that the captain and his mate want to be the first to
claim their seats in the life boat, ahead of women and children. By releasing
that most optimistic report Wilkins and Sokalsky
jacked up the share price artificially so that they could exercise their
options, only to sell the shares right away while selling was still good ? and leave shareholders to
their fate. If the share price collapses thereafter, too bad. The main thing
is that captain and mate were home safe. Shareholders can be Barricked.
The sight of
the captain and his mate grabbing the first seats in the life boat ahead of
women and children is repulsive enough. But it is impossible to find the
right words to express moral indignation if we consider that the mate is
personally responsible for the calamity awaiting shareholders aboard the
badly damaged ship, caused by the insane hedging policy of Barrick.
As reported in
this column, I have challenged Sokalsky to explain
why he had failed to heed my warning ten years ago that the unilateral
hedging policy of the company is not only false but extremely dangerous for a
gold mining company, in view of the 100% mortality rate of irredeemable
currencies. I also gave him a copy of my 50-page memorandum entitled Gold
Mining and Hedging - Will Hedging Kill the Goose to Lay the Golden Egg? which spelled out that there was such a thing as bilateral
hedging. It is harmless and potentially just as profitable even in a bear
market as unilateral hedging, if not more profitable. Above all, it is true
hedging as opposed to false hedging.
My challenge
has been ignored. Now we know why. Sokalsky and his
boss were busy bailing out. Is S.S. Barrick sinking
after hitting the iceberg of $700 gold? Time will tell. The ship is certainly
badly damaged by the collision. The question Barrick
shareholders must ask themselves is whether it is wise to entrust their
fortunes to a heavily hedged company whose chief financial officer has just
reduced his own exposure as a shareholder to zero and, together with the CEO,
apparently has better ideas where to park his money. The case for owning Barrick shares speaks for itself.
In Part Three
of this series I have explained the extremely precarious financial position
of Barrick due to its 9,5 million ounces of open
hedges, already deep under water, in a rising gold-price environment. Barrick's strategy is built upon the assumption, spelled
out in the company's last Annual Report, namely, that gold lease rates
remain stable. This assumption has now been fatally shaken by events in
the gold market during the past couple of weeks. The specter of the supply of
lease gold drying up looms large in the horizon. In consequence lease rates
could explode, making one ounce of gold in hand worth several ounces in the
bush (that is, locked up in ore reserves). There is no way to hedge against
the risk that demand for cash gold will surpass
supply of gold for lease. It is totally irrelevant what Barrick
says about the flexibility of its arrangements with the bullion banks. Barrick's capital may turn out to be insufficient while bleeding
gold in delivering mine output into the hedgebook
for nothing. It is entirely possible that we are witnessing danse macabre, the last contango
for Barrick. Backwardation of gold remains an
enormous threat to Barrick's survival. After all,
Messrs. Wilkins and Sokalsky should know best. They
don't want to own Barrick shares. They have voted.
With their feet.
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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