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Dear Mr.Kingston:
Thank you for writing. You
ask me whether Barrick is a ‘buy’ now
that it has reached its long-time ambition of becoming the first: the largest
gold producer
of the world. Would it now start moving up from its place of being the last:
the world's worst large-cap share price-performer in the gold-mining
business?
I am a monetary
economist and as a rule do not offer investment advice. Having said that, the
name "Barrick" touches a raw nerve in me.
I used to be a shareholder. In 1992 I took early retirement from my
professorship, accepting bribe money (they call it ‘golden
handshake’) from Memorial University of Newfoundland, my academic home
for 35 years. At stake was about $50,000 which I invested in Barrick shares and leaps, with the idea of arbitraging
one against the other. As the gold price went up, I would sell leaps and put
the proceeds into shares, and vice versa. Most of this investment has gone up
in smoke as a result of Barrick's ‘Brave New
World of Hedging’. I decided that, in reply to your kind letter, I
would tell my story.
The Godfather
Barrick's founder and
godfather, Peter Munk, like myself,
grew up in Budapest.
Truncating the original ‘Munkácsy’,
a name his family shared with one of the most famous Hungarian painters Mihály Munkácsy, Munk got himself a new name when he landed in the New World. We did not know each other but, as
schoolboys we had the same experiences, spoke the same street jargon, and
trod on the same cobblestones. Above all, gold loomed large in our lives,
making an indelible impression. In 1944 Munk's
father bought their exit visas from German-occupied Hungary to neutral Switzerland, along with a
train-load of other Jews, all paying for their escape with gold. The Swiss
government agreed to play the role of go-between.
I learned
about the life-saving properties of gold a few months later in a different
context. When the Red Army placed Budapest
under a siege those who had gold ate; those who didn't went hungry. My family
did not have much gold, but there was a heavy gold chain that used to hold
the gold pocket watch of my grandfather in better days. The watch itself had
been bartered away in hard times for food before I was born during the hyperinflation
following World War I. During the next hyperinflation, following World War
II, dentists refused to take paper money for professional services rendered.
My mother paid for dental work needed by my sister in gold. I still remember
the dentist's delicate hands: he clipped off an agreed length of the chain.
And his face: he had the smile of Shylock as he was preparing to take his
pound of flesh. My mother gave me the remnants of that gold chain, thus
abridged, before she died. My wife has it now. It has been fashioned into a
pretty bracelet.
Munk
came to Canada to study
electrical engineering at the University
of Toronto. During the
pre-Christmas shopping seasons, as a student he was arbitraging Xmas trees
between the parking lots of various supermarkets. When I came to Canada in 1957 I already had my university
degree and settled down to a teaching career in Newfoundland. Munk
as an electrical engineer went into producing high-end stereo systems and met
his first Waterloo in Nova Scotia. He had made the bad decision
of accepting government financing for his factory.‘Never again!’ he vowed after his
business deal with the provincial government unraveled
and he lost his entire investment. (This did not prevent him, years later,
from courting retired politicians such as former Prime Minister Brian Malrooney of Canada, and Ex-President George Bush, both
of whom took their seats on the ‘Advisory Board’ of Barrick.) The next bad decision was to design luxury
hotels (never actually built) in the shadow of the Egyptian pyramids, an idea
about as brilliant as setting up a pork-chop stand in Jerusalem.
A
little bit of etymology
Munk initially
conceived American Barrick in 1980 as a junior oil and
gas company. In 1983 he reconstituted it as a gold mining company, renaming
it Barrick Gold. If you have read my piece ‘Ultracrepidarian Musings’, then you know that I
have an avid curiosity about the origin of words. Naturally, I could not
resist the urge to research the word ‘Barrick’.
At an early brain-storming
session, as described in the authorized biography of Munk,
the question was raised how to name the fledgling company. Munk, who was obsessed with big and quick success, had no
patience with such trivial details, exclaimed: ‘Call it Baszik, Szarik, Barrick, as you will; I couldn't care less’. The
name Barrick stuck. Knowledge of the Hungarian
language helps the etymologist. The first two words’ English
equivalents are ‘f...ck’ and ‘sh...t’. In Hungarian four-letter words have six letters
to sport and, as verbs, they are also distinguished by their ‘-ik’ ending, forming a special conjugation class of
their own.
Gold mining and hedging: killing the goose laying the golden egg?
As a shareholder I was
concerned about Barrick's preposterous ideas on
hedging. Munk was fond of using innovative
financing techniques and Barrick boasted that its
credit standing is second to none, due to its unique hedging policy. I
realized that the word ‘hedging’ as used by Barrick
was a misnomer. It is not hedging at all, any more than a shill is winner at
the poker table. The appearance is that she is winning big; in fact she has
to surrender every cent of those gains to the casino owner at the end of the
day. Barrick was simply selling its production
forward, at one point as far as five years out as measured by current output,
with settlement postponed, at the option of the ‘hedger’, for as
long as fifteen years. Imagine, no margin calls for
fifteen years, no matter how much the price may move against your position! Barrick justified this insane policy by the statistical
Principle of Mean Reversal asserting that all economic indicators, including
prices (however volatile) ultimately tend to return to the mean. Fifteen
years was considered sufficiently long for even the most ‘absurd’
spikes in the gold price ‘to correct’. I demurred. Gold was an
exception to mean reversal. In a hyperinflation, after the ‘dead cat
bounce’ of paper money, you could wait till doomsday for the gold price
to correct.
I wrote a paper with
the title Gold mining and hedging: killing the goose laying the golden egg?
In it I explained that forward selling must be carefully distinguished from
hedging. A proper hedging strategy would require that the mine channel
production into a fund, which would then buy gold in the open market when the
price was low and falling, and sell when the price was high and rising. The
income from this arbitrage would more than make up for lost revenues from the
outright sale of mine product. Above all, such a strategy would not impart a
bearish sentiment to the market. Speculators knew that the gold mine would
sooner or later step in as a buyer whenever the gold price weakened, and they
would try to preempt it. They would want to buy
first. And conversely. The chips could fall where they may.
But since Barrick had an established policy of selling forward, and
never buying forward, speculators would abandon the long side of the market
in droves. They would move to the short side en bloc, in trying to forestall Barrick. They would want to sell first. Under these
circumstances the chips could no longer fall where they may. Fall they did
alright, together with gold. The gold price was effectively capped. Worse
still was the long-term effect. Just as you cannot ‘cap’ an
active volcano, you can't cap the gold price forever either. It is bound to
erupt and, when it does, you can kiss good-bye to the Principle of Mean
Reversal. In the end Barrick could be saddled with
a king-size liability that it may never be able to live down.
Shareholders do not
need to have a PhD in vulcanology to find this out.
As soon as they do, they will vote with their feet.
Shareholder-proofing
corporate governance
Indeed, they have no
alternative. After the Nova Scotia
fiasco Munk decided that he would construct a
corporate structure that would be ‘shareholder-proof’. He
developed the ‘perfect poison pill’. Not only will Barrick never be the victim of a hostile take-over bid,
shareholders will have to eat from his hands. The corporate governance of Barrick epitomizes this. Shareholders are pariahs,
sacrificial lambs on the altar of high management policy. They have the right
to vote with management. But that's about all. In case of a disagreement they
can go and fly a kite. Management lives in its own world of an unassailable
bunker.
In 1994 I did not
know this. I was naive. I wrote a letter to Munk
asking him for a meeting. I wanted to present to him a copy of my paper with
my compliments. In reply Munk told me that I had to
show my paper to his Senior Vice-President and CFO, Jamie Sokalsky
first. By the time I could see Jamie company headquarters were moved from
Yorkville, a bohemian district of Toronto, to the Royal Bank
Towers downtown,
projecting an entirely different corporate image. The significance of this
move was lost on me at the time. I believed that I could convince Sokalsky of the errors of Barrick's
ways.
The meeting lasted
for two hours. I could see from his occasional remarks that Sokalsky understood everything I have said. He did not
argue with me. He said that what I was talking about was all very interesting
and promised that he would read my paper carefully and give me a written
answer. I have never heard from him since, nor have I heard from Randall
Oliphant, the President of the company. Both men were fired later by Munk as shareholder dissatisfaction with the company's
hedging policies, and with the low-altitude flight of the share price, could
be heard inside of the bunker, sound-proofing notwithstanding. Scapegoats had
to be thrown to the wolves to keep the latter away from the door.
I sold my
shares and leaps, as did thousands of others. And I went back to my own den
to lick my wounds.
If forward
sales, why not forward purchases, too?
Barrick never explained
to the world what has happened, or how they would fix the flawed policy. Even
today, the new guy at the helm President Greg Wilkins defends the policy of
‘a reasonable level of hedging’ as an ‘essential
risk-management tool for the company’. It is supposed to
‘stabilize revenues and satisfy banks that finance its projects’.
But if this were true, then the policy should be made even-handed. Barrick has never admitted that its one-sided forward selling was
responsible for the bearish bias in the gold market for the last decade of
the century and the millennium.
In my paper I
suggested an easy way to repair this bias. The company could complement its
forward sales by forward purchases. These are triggered whenever the gold
price is low and falling. Just as the gold mine lifts its short hedges as
production is delivered into the hedge book, it can lift long hedges as deals
to buy new gold properties are being closed out. In this way the mine can
acquire new gold properties at the best possible price. I have evidence that Sokalsky understood my point perfectly well, the point
being that the bias against the long side of the market would be removed as
speculators would be coaxed back to it. Quite possibly my paper was in the
hands of the top brass when they discussed the dismal failure of their policy
of unilateral hedging, as it dawned on them when the new century and
millennium did. For all I know, Sokalsky could have
proposed as a face-saving measure my idea of ‘bilateral hedging’
which, for him, could have been a ‘skin-saving’ measure as well.
Is Barrick a front to cover up gold-laundering?
That is, unless Barrick was a front to cover up gold laundering by
governments, in which case unilateral forward selling was not a mistake but a
deliberate policy. I couldn't help but believe that the company had a vested
interest in suppressing the price of gold. Its ambition to become No. 1 also
points that way. It is not about vanity. It is about pricing power. The
suspicion that Barrick is a front to cover up a
gigantic gold-laundering operation, presumably on behalf of a government (or
governments) that need more time to complete a gold-acquisition program in
the order of thousands of tons of gold, is hard to escape. Incidentally, if
you interpret ‘gold laundering’ as a polite expression for
‘stealing shareholder gold’, no harm done
Clearly, such a
conspiracy theory can never be proved or disproved. I was not the only one
who suggested it. GATA and Golden Sextant named Barrick
as a co-conspirator in the illegal scheme to suppress the gold price.
When in the
early 1990's Barrick sued the United States
Treasury over a user-fee issue and, implausibly, won in the court, I failed
to smell the rat. Only later did this lawsuit appear like a whale-size red
herring to me, dropped to deflect suspicion away from Barrick
lest someone think it was a front. “Behold, little David conquering the
towering Goliath! What rubbish it is to suggest that David was bribed by
Goliath to do it!” At about the same time Barrick
moved its headquarters to shed its image as a maverick, to assume the image
of a ‘responsible corporate citizen’. No longer did it have to
rub shoulders with hippies after its credentials were established beyond the
shadow of a doubt.
Achilles heel,
or noose around the neck?
One analyst has called its
hedge book Barrick's Achilles heel. But to others
it looks more like a noose around the neck that no amount of ‘creative
book-keeping’ or ‘off balance-sheet financing’ can hide
forever. It has been stated publicly that Barrick
would be bankrupt if it marked to market its liabilities. Wilkins gave
himself till the end of 2009 to clean up the mess and reduce the hedge-book
from 14,3 million ounces of gold to 9,5 million. But
by that time the gold price could be well into four digits. The question is
whether the kindly and gentlemanly bullion bankers will honor
their ‘no margin calls for fifteen years’ pledge at those lofty
prices. If shareholders can't throw the rascals out, maybe the bullion
bankers can, and will.
Maximize life, not profits
In the meantime an even
larger business challenge is confronting Barrick in
the shape of a cost-of-production squeeze. Under a gold standard, the gold
miner typically mines his property most conservatively. He goes after
marginal grades of ore, the most expensive to exploit, where a base metal
miner would go after the highest grades, the least expensive. The gold miner
is not interested in maximizing profits as is the base metal miner. And for a
very good reason, too. The marginal utility of a base metal declines. The
miner wants to extract it from the bowels of the earth before the price may
drop even more. By contrast, the marginal utility of gold is constant. There
is no rush to dig it up, only to bury it again in bank vaults. Therefore the
gold miner wants to maximize the productive life of his mine, not profits. Barrick threw this wisdom of the trade to the winds as it
has been mining the highest grades of ore available, and at break-neck speed
to boot. Now it has to face the consequences. Its mined-out properties will
have to be closed down prematurely, from which gold has been extracted and
sold at what must, in retrospect, appear as give-away prices.
My suggestion
of forward purchases of gold combined with the miner's problem of premature
exhaustion of gold properties, would have made a
perfect fit. Barrick would have been in an extremely
strong position to buy new gold properties while lifting the long hedges it
had put on when the gold price was much lower.
The Best Little Whorehouse in Nevada
Here is how a reporter
described the scene at Barrick's annual meeting of
the shareholders in Toronto's
Metro Convention Centre last spring:
“The sky is dull
grey, but the mood inside is dazzling. Pockets of spontaneous applause break
out during the presentations. Standing at a podium emblazooned
with the Barrick logo before a cinemascope-sized
graphic display of the company's global reach, Wilkins leads shareholders
through the past year's triumphs, and hints at a long and prosperous future
for a company that now has unprecedented size and clout.
“He is followed by
the 78-year old Munk, resplendent in a dark grey
pinstripe suit, pale blue shirt and a luminescent pink tie. Munk pauses for effect and then leans over the podium. In
a gravelly voice speckled with traces of his Budapest childhood, he
delivers a rumination that is both self-congratulatory and self-deprecating,
at once a nod to Barrick's humble origins and a
prelude to a glorious future.
‘I can't help but sit back and say that what we have done here
has been spectacular’, he says. ‘But it's not the mines, it's not
the reserves, [and] it's not the credit rating that's the best in the
industry. What makes me proud, what makes me
exceptionally happy, are the intangibles...those intangible values of
integrity from which every decision automatically springs. It's the culture
that this company has had in its DNA from the time it bought Camflo Mines’.
“You should give as good as you get. Integrity, as Munk
says, means many things in gold mining, including paying people fairly for
their work and contributing to local communities. It can even mean, he says
puckishly, funding and building housing projects for miners in places like
Elko, ‘that dusty, miserable Nevada
town with one whorehouse’.”
Hey, Munk,
wait a minute! It's all very well to fund and build posh whorehouses where
miners and top brass can Barrick to their heart's
content! But what about the share price? What about the patrimony of the
shareholders?
Shareholders? They will be Barricked.
Again.
I know it. I have been there.
Yours, etc.
Antal E. Fekete
Former Barrick
shareholder
August 11, 2006.
References
Charles Davis, So Big It's
Brutal, Report on Business,
The Globe and Mail: Toronto,
June 2006, p 64-73
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
A.E. Fekete, The Texas Hedges of Barrick,
http://shoemakerconsulting.com/goldisfreedom/archives/Texashedges.
May 2002
Ferdinand Lips, Gold Wars:
Will hedging kill the goose laying the golden egg? p 161-167,
New York:
FAME, 2002
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 AUTHOR’S
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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