Barrick's Buy-Back Comes at a Bad Time

Tuesday evening we learned that gold producing giant Barrick Gold (ABX) has decided to issue $3 billion in new common equity shares in order to buy back all of its remaining gold hedges, which are currently in the red, to the tune of $5.6 billion.

In the company’s press release, Barrick explained that investors have expressed disappointment that the company has hedged 9.5 million ounces of production below market values. Barrick claims such a fact has put pressure on its share price, and therefore seems to have concluded that lifting their hedges is good for shareholders.

The press release also included reasons why the outlook for gold was positive (as would have to be your view if you decided to lift out-of-the-money hedges), but is this really the best time to be lifting hedges? I’m skeptical about the timing of this decision and therefore am glad that I am not a shareholder in Barrick.

As you may have seen, gold prices have risen sharply in recent weeks (chart below) and now trade near $1,000 an ounce for the third time over the last couple of years. The metal never seems to stay over $1,000 for long, even in the depths of the credit crisis. Barrick has decided, seemingly based entirely on pressure from shareholders, to go 100% long on gold just as the metal is nearing its all-time high. I thought we were supposed to buy low and sell high?

Barrick is going to pay $5.6 billion to lift its hedges, which is the mark to market loss it has on the books right now. On 9.5 million ounces, that means the company is underwater by $589 per ounce and must pay that much to get out of them. That means Barrick is partially hedged at $411 per ounce with gold at $1,000.

Now, I am not saying that hedging gold at $411 per ounce makes a lot of financial sense in current times. I certainly understand that investors want to see them lift those hedges. After all, if you are long ABX stock, you clearly think gold is going to rise in price, and therefore would want to benefit if that view proves correct. Still, from a financial management perspective, Barrick is essentially buying at the top of the market.

Why not wait for gold to drop to $800 or $900 before lifting the hedges? That would be a “buy low” type of move and even buying at $900 per ounce would save the company $1 billion in cash, versus making this move right now.

The converse argument would be that gold might not trade back down to $900 or lower, but that seems unlikely. The chart above shows us that gold prices couldn’t even stay above $1,000 during the worst credit crisis we have ever faced. In fact, gold traded at $700 less than twelve months ago, at $800 earlier this year, and at $900 just a few months ago.

Gold is typically seen as an inflation hedge as well as a flight to safety when fear is the paramount emotion on Wall Street. We have clearly already lived through the scariest part of this recession. In addition, inflation is unlikely to rear its head anytime soon because firms have little or no pricing power with such a weak economic situation (consumers and corporations are cutting back whenever possible, and demanding low prices, thereby rendering near to intermediate term inflation risks mute).

This $5.6 billion long bet by Barrick Gold with the metal trading at $1,000 an ounce looks like a bad idea to me and I would not be buying gold investments right now. Unfortunately, it appears that the company was forced to act by its shareholders, who likely have a biased view of exactly where gold prices are going to go from here.

If I were running Barrick Gold I would tell my shareholders, “look, we understand where you are coming from, and will look to lift the hedges when it makes sense, but not when prices are approaching all-time highs. Maybe on a pullback we will take swift action.”

Time will tell whether this move pays off for Barrick’s investors or not. In the meantime I believe it is a good time to be cautious on gold.

Full Disclosure: No position in ABX at the time of writing, but positions may change at any time.

Comments

[NUCLEAR1929:]

barrick is not miner anymore, its a trader
in general its very bullish or was bullish short term for gc

Sep 09 10:39 AM

[Mad Hedge F...:]

cvn. The precious metals markets were stunned with Barrick Gold’s (ABX) announcement that it will float a $3 billion public offering to retire its gold hedges in the futures markets. The means that the world’s largest producer is cashing in its downside production and gearing itself for a ballistic move up in the price of the barbaric relic. The timing of the announcement, the day that the yellow metal broke $1,000 for the first time since February couldn’t have been more auspicious. I have been a huge fan of Peter Munk’s ABX all year, cajoling readers into the stock at $27 in January before its 56% run (click here for report at www.madhedgefundtrader...) . South Africa’s largest gold miner, AngloGold Ashanti’s CEO Mark Cutifani says his company put its money where its mouth is, taking off its hedges some time ago. “People are doing what they have been doing for 5,000 years, and that is buying gold as the only hard currency,” opines Cutifani. In the meantime, the Street Tracks gold ETF (GLD) announced that it has $34 billion of gold holdings, making it the largest ETF of all, and the fifth largest owner of gold in the world after four central banks. If you want to buy gold bullion or coins for the tightest spread over spot, check out www.millenniummetals.net by clicking here.

Sep 09 10:49 AM

[Roger Knights:]

"We have clearly already lived through the scariest part of this recession."

Famous last words.

Sep 09 10:51 AM

[Yogibear101:]

....it's simple, they got a margin call, don't have the cash or gold to pay it, so they dilute the shareholders. Obviously the news was known to the underwriters and several others well in advance. All they needed to do was spike gold to $1000, force short covering, unload their shares into the rally, or buy puts & sell naked calls while shorting the short covers. It was a NO RISK short since they can coverbuy at the offering price. Once they're done with this scheme, gold will drop like a rock. I give it one or two days.

Sep 09 11:53 AM

[Barbarous R...:]

Why do you think gold has had this big run recently? A large part of the move in recent days was very likely caused by Barrick already conducting its hedge buyback program.

This announcement suggests that the rally may not last.

Sep 09 12:08 PM

[Yogibear101:]

....you can't buyback a hedge when you're broke and get the margin call. Plus, paying it back with physical at the hedge price means they take a loss instantly, as the mining cost per ounce is higher than the hedge. Covering with shareholders equity and offering cash is painless, yet it closes out a 9.5 million ounce artificial demand for gold.

Sep 09 12:30 PM

[Craig Hemke:]

You clearly have no idea what's going on.

Sep 09 12:57 PM

[Yogibear101:]

On Sep 09 12:57 PM Craig Hemke wrote:

> You clearly have no idea what's going on.
----------
Talk to me on Friday, after you figure out what's going on.

Sep 09 01:11 PM

[Eduard Fischer:]

Financing at a lower gold price would have also meant more dilution of stock by selling at a lower share price. I think that if you crunch the numbers you will find that the present higher gold price and higher share price is a better deal for Barrick than a lower gold price, lower share price. Besides that people are hyped on gold right now so that Barrick seems to be having no trouble placing 4 billion $ worth of shares to do this deal. That may not have been the case when the gold price was in the doldrums.

Sep 09 01:23 PM

[Yogibear101:]

stockcharts.com/script...?$gold,$silver,gld,slv...

Get the picture?

Sep 09 02:13 PM

[Yogibear101:]

Lemme try that link to charts again

tinyurl.com/pmstoday

preview.tinyurl.com/pm...

Sep 09 02:16 PM

[kohalakid:]

I'm not sure what you mean by saying they can't buy back the hedge.
Of course they can. They can offset it anytime they want.


On Sep 09 12:30 PM Yogibear101 wrote:

> ....you can't buyback a hedge when you're broke and get the margin
> call. Plus, paying it back with physical at the hedge price means
> they take a loss instantly, as the mining cost per ounce is higher
> than the hedge. Covering with shareholders equity and offering cash
> is painless, yet it closes out a 9.5 million ounce artificial demand
> for gold.

Sep 09 03:50 PM

[petersl:]

Yes, time will definitely tell. A monumental struggle between the bears and bulls on the price of gold is taking place right now over the battleground around $1000 per oz. I see Barrick's move as the correct one, albeit a little tardy in the execution. We should see a resolution of the struggle in the next couple of weeks, probably by the end of this month, which is historically a good one for precious metals. Don't forget to watch silver, and BTW, buried in the news coverage of Barrick's elimination of its hedge position (over time), was the news that Barrick also sold 25% of its silver production to Silver Wheaton from Pascua Lama's forthcoming production stream, getting a cash infusion in return for selling silver at $3.98 per oz to SLW under the agreement. This is a "win win" for both ABS and SLW.

Sep 10 08:59 AM

[Econ 101:]

I dont understand why Barrick cant hedge its gold now at $1000 per ounce (ie sell puts) and liquidate (buy back the $411 puts) hedges with that money?

Sep 10 11:48 AM

[Yogibear101:]

They sold calls at $411 that are now worth $1000. That's why they can't sell more to buy back the originals. Plus "somebody" wants their money rather than the gold. Only avenues are chapter 11 or sell more shares.

Sep 10 12:54 PM

[ProfMatt:]

There has been a move in banking credit departments to adopt mark to market agreements (aka collateral agreements) and my bet is Barrick has none in place with its bankers, and all their bankers are knocking on their doors for one. So now there's a multi-billion dollar "margin call". Once their banks are no longer financing their $5BB+ debts for free - a process called historical rate rollover which is frowned upon in many banking circles - there leaves no good rationale to maintain the hedges.
If anything, the $3 drop in their share price removes a premium, or creates a good discount to buy.

Sep 11 05:06 PM