Barrick Gold Nails the Hedge 13 comments
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By Julian Murdoch
It's gold week around here at HardAssetsInvestor.com, so let's take a look at a company that pulls the shiny stuff out of the ground. It happens to be one of the biggest players in this space, and it happens to have reported earnings this last Friday: Barrick Gold Corp (NYSE: ABX). (See earnings call transcript.)
Why look at a gold company if you are a commodity investor? It all depends on how you like to play. There are advantages and disadvantages to pick-and-shovel plays - we discussed some of them in Gold Vs. Miners back in October.
One of the interesting ratios we looked at was the price of gold compared with the value of the Amex Gold Miners Index (GDM). While this is an invented ratio, it's worth tracking over time. Back in October, the ratio of the price of gold to the value of the Amex Gold Miners Index was above 1.5 - a high number, historically, implying that gold miners were cheaper than they'd been in years. In October, gold prices were in the $750 range, and the Amex Gold Miners Index was sitting around 500.
The picture has changed a bit now.
The ratio is currently playing much closer to 1-to-1. Even though gold has climbed to $1,000/ounce, gold companies' stock prices have risen too - sending the GDM climbing to similar levels.
Barrick Gold Corp
With that in mind, let's look at Barrick.
Like many stocks (in many sectors of the economy), Barrick has had tremendous swings of late.
After big drop-offs in June, August and September, the stock bounced back a healthy 78.4% from the low of $18.14 it hit on October 27, 2008. But even with the jump, Wednesday's closing price of $32.36 is still almost 40% lower than its 52-week high of $53.55. And that downward spiral you see at the end of the chart? That's just Barrick dropping along with the rest of the market at the start of this week.
Last Friday, Barrick announced earnings that beat analyst estimates by 1 to 2 cents a share (depending on who you look at - Reuters or Bloomberg). That "beat" is dwarfed by one-time charges, which pulled the fourth-quarter results into the loss column.
The reason behind the beat is more complex than just pricey gold. Remember, Barrick Gold Corp. is not a pure gold play - no matter what its name says. It does do the majority of its business in gold, but it also plays in the industrial metal markets with its copper production.
Perhaps more importantly, Barrick employs a disparate hedging strategy. It eschews gold hedges, but does hedge copper as well as other nongold assets, such as oil and currency (Australian dollar).
Since Barrick does not hedge its gold, one would expect to see its stock performance closely mirror that of spot gold - at least to some degree. And usually, it has.
But look at what has happened recently. Beyond the stock price taking a larger hit than gold, we can see points of divergence - specifically in the recent past. At the tail end of the chart above, spot gold rose, but Barrick's stock fell. It's a similar pattern, in abstraction, to what's happened throughout down cycles in the last year. Whenever stocks take a serious plunge, Barrick goes with them, while gold itself stays relatively strong in comparison. Classic safe-haven behavior, but still, obvious high correlations to gold.
Compare that to copper:
Clearly the market understands the copper hedge. Barrick reported that it averaged $3.06 a pound for copper during the fourth quarter - compared with an average copper spot price of $1.79. Plus, Barrick managed to produce more copper than was expected. Both bright spots on the balance sheet.
Where's The Profit?
So we have this company that produces both gold and copper - metals that have very different roles in the economy. Gold - the flashy high-priced one with little industrial utility; and copper, the boring one that is in demand on the industrial side of things. Both are affected by the state of the global economy, but in different ways.
The obvious question is one of sensitivity: How exposed is Barrick to each metal? How exposed is the company to the ups and downs of the commodities it produces? It would seem to be an easy question to ask and answer, but if you are interested in this simple data, you have to wade through pages and pages of management discussion to find it. In this case, it was on page 67 of 116 of Barrick's year-end report.
Sales | Expenses | Income | |||||||
(mm) | % | (mm) | % | (mm) | % | ||||
Gold | $ 6,656 | 84 | $ 3,426 | 88 | $ 4,493 | 80 | |||
Copper | $ 1,228 | 16 | $ 436 | 11 | $ 1,137 | 20 | |||
Total | $ 7,913 | $ 3,876 | $ 5,630 | ||||||
Here's the beauty of locking in the right contract price. At least for 2008, copper - a market in decline - was simply more profitable than gold. Interestingly though, copper's sales as a percentage of total sales was lower in 2008 than it was previously. In 2007, copper accounted for 21% of total sales. Meanwhile, gold has accounted for a larger percentage of total sales (by dollar amount) - gold was 79% of total sales in 2007 compared with 2008's 84%. That's the rising price of unhedged gold in action.
The breakdown of expenses between the two metals has remained largely stable - with copper accounting for roughly 11% of total expenses for both 2007 and 2008.
All that's the long-winded way of saying that Barrick, at least for 2008, benefited from hedging copper prices while maintaining control of expenses in a big way. At the same time, Barrick's unhedged gold operations were able to reap the rewards of higher prices. This is also borne out with another simple statistic from their report:
Gold: Average spot (ounce) | $ 794.00 |
Gold: Average realized (ounce) | $ 807.00 |
Copper: Average spot (pound) | $ 1.79 |
Copper: Average realized (pound) | $ 3.06 |
In other words, they simply got it right. It's worth pointing out, however, that these are operational figures, and when you spend your evening with their numbers, they can often seem buried underneath the weight of exploration, M&A activity, capital projects and the like. So while Barrick had record cash flows from its core operations, it still reported negative financial earnings.
Conclusion
The thing to remember when looking at commodity companies - especially mining companies - is that there really aren't any pure-play companies. The big mining companies have multiple products that they are producing and it pays to look closely at how much of each they are pulling out of the ground and where their profits are coming from. It may turn out that the company you are looking at for gold exposure isn't as exposed as you would like. For more of a pure-play option, you'd have to look at true junior miners - a topic for another day, and a risky proposition in any economic climate.
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I guess he wants the "rich" to sell stocks and bonds and pay off the balance of their mortgages. Or, sell their homes and rent.
Does anyone really think that he'll readjust tax brackets for inflation when Joe Sixpack suddenly finds himself making $250,000 annually, after he has destroyed the value of the dollar?
From your article:
"Since Barrick does not hedge its gold, one would expect to see its stock performance closely mirror that of spot gold - at least to some degree. And usually, it has."
Barrick doesn't hedge? It's been my understanding that Barrick has the second largest hedge book on earth, after Anglogold Ashanti.
Check out this report (pdf warning):
www.gfms.co.uk/Market%...
"The largest activity came, once again, from the holders of the two largest hedge positions, Barrick Gold and AngloGold Ashanti."
And now, from the earnings call you cite in your article (did you read it?), Barrick officers are repeatedly assailed about their hedge book; their answer seems to me to boil down to "we're gonna worry about it later." Are they talking about the 9.5 million ounces Barrick hedged at $325 an ounce mentioned in this 2007 article:
www.reuters.com/articl...
"Barrick's hedge book has 9.5 mln oz gold at $325/oz"
The earnings call:
"Greg Barnes – TD Newcrest
Okay. Just a quick question to Aaron. What’s your view on the hedge, Barrick’s hedge, the 9.5 million ounces? If your view is that gold price could go to $2,000 just an example, what do you want to do with it?
Aaron Regent
Well, I think the hedge -- let me maybe start by saying, you know, the policy with respect to gold hedging is not to do any more gold hedging. And I think it would be -- we prefer that and we will closely manage their hedge book over time. I think that what we will do is we will manage it in a prudent fashion. And to the extent that we want to do something more aggressive that takes off (inaudible) capacity and we have to balance off that option versus other potential opportunities for the company. So I think I’d say it’s something that is managed and looked at quite carefully.
Greg Barnes – TD Newcrest
So you would weigh it off against -- in terms of paying it down or buying it back, I guess you would weigh it off against investment in Pascua Lama or assume your other development projects is how you would look at it?
Aaron Regent
I think so. At the end of the day, it’s a capital allocation decision. And so we have to look at -- if we deploy capital against the book, we deploy the capital somewhere else, what’s going to create most value for the organization. So I think that’s the thought process that we have to continually look at and review."
"Heather Douglas – Thomas Weisel Partners
Okay. And I have a follow-up question on the hedge -- on the hedge book. As it stands with your current agreements with your various counterparties, when do you have to start delivering into the book?
Jamie Sokalsky
Well, Heather, it’s Jamie again. The agreements provide for generally around ten years before the termination date. And so while we have allocated them to the projects, they are still subject to the very strong, very favorable terms that we have negotiated in the past on these agreements. And so we do not have to start delivering. We have the ability to deliver any time within that largely ten-year time horizon for the bulk of the contracts. So it’s at our option within that time period under these committed agreements. Having said that, we’ve allocated them against the projects. And as those projects come into production, we’ve allocated them in the years from 2012 onward as the initial protection for our project financing that we are anticipating for that portfolio of projects."
"Tanya Jakusconek – National Bank Financial
Okay. And you had mentioned that on the project development the feasibility studies you were expensing so far. I was just trying to get a better idea for what then is coming through in terms of these book values. And then just lastly on your hedge book, just to make sure that your counterparties, you still have 20 of them, Jamie?
Jamie Sokalsky
There are 17 counterparties that we have positions with, Tanya.
Tanya Jakusconek – National Bank Financial
And no one has more than 10% of your hedge book?
Jamie Sokalsky
We allocated some ounces after December 31 to another counterparty. So one has 13% of the ounces mark-to-market, and none of the others have more than 10%.
Tanya Jakusconek – National Bank Financial
Okay. And then just lastly, none of the counterparties have basically asked for the right to start delivering?
Jamie Sokalsky
No, the -- what -- where we are is, we have, as you know, the ability to deliver any time within that time period of the ten years I talked about earlier. We have this evergreen feature in the contract. So if the counterparties do not notify us that the contracts get extended for or the agreements get extended for another year, during 2008 three of the counterparties indicated that the agreements -- they weren’t going to extend it for another year. So those agreements are now around nine-year type facilities.
Tanya Jakusconek – National Bank Financial
Okay. So three of them have come back and said, okay, we want to start delivery nine years from now?
Jamie Sokalsky
Currently that’s the termination agreement of the -- termination date of the agreement. That’s right. And 14 continued to extend for a further year."
Barrick seems to have millions of ounces of gold hedged at $325 an ounce, not exactly a winning position with gold north of $900.00. Is the author even aware of this? Are we looking at the same company?
The CC answers are evasive rather then clear and direct. It is a very stupid tactic since everybody reading the company security reports know the real answers.
9.5 mln oz gold is almost ABX 1.5 years gold production. And with ABX $450/oz gold production cost, ABX is in a deep financial hole.
If gold continues going higher, miners will eventually follow.
Let's take a more macro look at gold and the U.S. dollar.
What is the one thing that the economy, government, markets, financial system is lacking? Confidence.
What is a currency that isn't backed by a physical commodity (i.e. gold, silver,etc)? Fiat Money System.
In a fiat money system, the value of money is based on Confidence.
What happens when all "Confidence" in money is lost? We enter what is called the "terminal stage of a fiat currency." The stage is called Hyper-Inflation.
"Gold has replaced every fiat currency for the past 3000 years."
The reason why the U.S. dollar is trending up with gold is because countries have lost faith in their currencies. They are exchanging their currency for U.S. dollars. This will be temporary at best.
Imagine what is going to happen when the world loses confidence in the U.S. dollar? The dollar will devalue and gold will rise even higher.
Here's the kicker. What happens to ALL those gold bullion investors holding $1500, $2000, $2500 per ounce gold? They can't exchange it for worthless dollars, right??? They are going to be stuck with the gold.
It's a vicious cycle.
On Feb 27 06:30 PM nova wrote:
> It appears that Barrick is more a gambling company rather than a
> mining one.
>
> The CC answers are evasive rather then clear and direct. It is a
> very stupid tactic since everybody reading the company security reports
> know the real answers.
>
> 9.5 mln oz gold is almost ABX 1.5 years gold production. And with
> ABX $450/oz gold production cost, ABX is in a deep financial hole.
>
lolz!
On Feb 27 09:35 PM Midas360 wrote:
> Your post screams "SHORT." It never makes sense for miners to outpace
> gold spot. The price of miners relative to gold spot screams "bargain."
>
>
> If gold continues going higher, miners will eventually follow. <br/>
>
> Let's take a more macro look at gold and the U.S. dollar.
>
> What is the one thing that the economy, government, markets, financial
> system is lacking? Confidence.
>
> What is a currency that isn't backed by a physical commodity (i.e.
> gold, silver,etc)? Fiat Money System.
>
> In a fiat money system, the value of money is based on Confidence.
>
>
> What happens when all "Confidence" in money is lost? We enter what
> is called the "terminal stage of a fiat currency." The stage is called
> Hyper-Inflation.
>
> "Gold has replaced every fiat currency for the past 3000 years."
>
>
> The reason why the U.S. dollar is trending up with gold is because
> countries have lost faith in their currencies. They are exchanging
> their currency for U.S. dollars. This will be temporary at best.
>
>
> Imagine what is going to happen when the world loses confidence in
> the U.S. dollar? The dollar will devalue and gold will rise even
> higher.
>
> Here's the kicker. What happens to ALL those gold bullion investors
> holding $1500, $2000, $2500 per ounce gold? They can't exchange it
> for worthless dollars, right??? They are going to be stuck with
> the gold.
>
> It's a vicious cycle.
>
While central banks traditionally have said they lease gold to earn a little money on a supposedly dead asset, in 1998 Federal Reserve Chairman Alan Greenspan told Congress that this was not true. Central Banks lease Gold, Greenspan adimitted, to suppress it price: Is Barrick still useing its ties to the goverment to continue its part in the goverments price controls schemes?? "Now that is the truth,if you read the testimony of Greenspan before Congress!
When the dollar crashes,people always say,at least you can burn dollars bills to stay warm,but if you do,the EPA will be all over you,it releases to many toxic chemicals crap ! Silver & Gold is Real money that never goes to zero!
The company has 125m ounces of reserves, and this hedge basically penalizes under 10% of the reserve as a wash with 0% profit possibility. With respect to the other 90%, they can capitalize on spot gold.
Since the market has known about this forward for a long time, it is not an issue and has already been well priced into the stock. (basically, with the hedge we're talking about 500-600m in forgone revenues per year for the next 10 years assuming gold were to average 900/oz over that period). But if gold went to $2k/oz, ABX's revenues on the unhedged portfolio would still more than double. Holding all other input costs constant (unrealistic), gross profit would move from $3b/yr to $12+ b/yr.. Quadruple in earnings, quadruple in stock price.
You get the idea why people like miners.
Otherwise, I share with you the belief that mining shares are set to stage a broad advance once money starts returning to equities. Take the medium term view and look where these shares were at the November 20-21, 2008 trough and how nicely they held on to their gains now as the market broke through that November low.
This remark is definitely not meant to undermine the good analysis you have offered.