giovedì 10 settembre 2009

Naked short: Barrick can't get gold to cover hedges

Barrick can't get gold needed to cover hedges

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By Adrian Douglas
Wednesday, September 9, 2009

Today Mineweb published a report by its writer, Dorothy Kosich, covering the announcement by Barrick Gold that it will eliminate most of its hedge book:

http://www.mineweb.com/mineweb/view/mineweb/en/page34?oid=88850&sn=Detail

But Barrick is not eliminating hedges by actually delivering gold. The company is instead raising cash to pay off its obligations. This is technically a default on the delivery of the hedged gold.

I recently wrote an article titled "A Run on the Bank of the Gold Cartel" in which I asserted that many factors are coming together to put stress on the physical gold market. See:

http://www.gata.org/node/7764

Paul Walker, CEO of the GFMS metals consultancy, said recently that the gold price has risen because there have been "large, lumpy transactions in a market that has a degree of illiquidity." I can't think of a better euphemism for a short squeeze.

A gold hedge is entered into when a gold mining company expects that the future price of gold will be lower than it is today. The company enters into a contract with a third party to sell some of its yet-to-be-mined gold in the ground. For this the company receives the cash value of the gold based on the prevailing spot price. The company then has an obligation to produce the gold and deliver it to the third party at some future date. If the gold price indeed declines, the company reaps a superior profit on its gold sales compared with selling the gold as it is mined at the prevailing spot price. But if the price of gold rises, the mining company has forgone some of its profit by having sold the gold in advance at a lower price.

Barrick has announced that the company is not delivering the gold it has sold forward. The company is raising cash from the sale of stock so it might deliver cash instead of gold. I don’t know if this is a default under the terms of the company’s hedge contracts, but it is technically a default because gold was sold for future delivery and the future delivery is not being made.

MineWeb's story says: "Barrick intends to use $1.9 billion of the net proceeds to eliminate all of its fixed price gold contracts within the next 12 months, as well as $1 billion to eliminate a portion of its floating spot price gold contracts. A $5.6 billion charge to earnings will be recorded in the third quarter as a result of the change in the accounting treatment of the hedges."

Essentially this means that some time in the past Barrick received cash for its yet-to-be-mined gold that the company now is having to pay back, along with considerably more, insofar as the company is recording a loss of $5.6 billion without a single ounce of gold being involved. This is not mining; it is gambling. And Barrick, and more importantly its shareholders, lost big-time.

MineWeb's story says: "The company's current gold hedges include 3 million ounces of fixed-price contracts where Barrick does not participate in gold price movements. The contracts have a negative mark-to-market position of $1.9 billion as of September 7. In addition the company has 6.5 million ounces of floating contracts where Barrick fully participates in gold price movements. The current negative $3.7 billion marked-to-market position of the floating contracts does not change with gold prices. No activity in the gold market is required to settle these floating contracts." [Emphasis added.]

In theory Barrick should have to go into the market and buy gold to deliver into its obligations instead of paying cash. Of course this would blow the gold price sky-high and thus might bankrupt the company in the process. But this is not the end of the story because the counterparty to these hedges, probably JPMorganChase, no doubt also has obligations to deliver to some other entity the gold it was expecting from Barrick -- maybe a central bank. Will the counterparty also be able to settle its obligations in cash or will significant quantities of gold have to be purchased? Barrick may be getting off the hook but this technical default creates a shortage of physical gold.

Many other mining companies, such as AnglogoldAshanti, that had undertaken disastrously unprofitable hedges when gold was selling at multi-decade lows and below its cost of production have been delivering their production into their hedge obligations. Barrick’s action is different -- a technical default on delivering physical gold that had been sold forward.

This is explosive news for the gold market. The run on the Bank of the Gold Cartel is unfolding. Much more gold has been sold than can be delivered. The implications for the gold price are mind boggling.

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Adrian Douglas is publisher of the Market Force Analysis newsletter (www.MarketForceAnalysis.com) and a member of GATA’s Board of Directors.

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