American Barrick Resources Corporation: Managing Gold Price Risk
DERIVATIVE CASES
CASE STUDY II
AMERICAN BARRICK RESOURCES CORPORATION:
MANAGING GOLD PRICE RISK
Group II - Cohort 5
American Barrick is the largest gold producer in North America. The implementation of the gold-hedging program differentiated the firm from other major gold rivals and improved its reserve and financial strength. In 1995, American Barrick ’s latest gold find necessitated the company to determine a new hedge strategy for its gold production.
I. Motivation
From the Exhibit 3, we find that few gold producers hedge their productions. Except the American Barrick, who hedged 94% of its 1992 production, other gold producers hedged only a small portion or none of their productions, therefore their gold’s mine sole output, and hence its profits, cash flows, and stock price were tied to gyrations in the price of gold[1]. In our opinion, the two reasons for gold-hedging program of American Barrick are:
1. Most of the gold producers would like to capture the full benefit of increases in the price of gold. They bet on the price of gold would go up in long term.
2. Gold is precious and easy to store, so most producers would like to store gold and sell it at a relatively high price. If the price of gold is lower than the producers’ expectation, they can store the gold with almost zero cost. This strategy is based on the low cost of gold storage and high liquidity of gold.
Compared to most gold producers, American Barrick operates more conservatively, which is the reason why it chooses to hedge most of its productions. Mr. Munk, the chief executive officer of American Barrick, emphasized the importance of having a strong, liquid balance sheet in the 1991 letter to shareholders.
In order to hedge the risk from gold price, the company has to give up the potential profit from the increase of gold price, because if the
CASE STUDY II
AMERICAN BARRICK RESOURCES CORPORATION:
MANAGING GOLD PRICE RISK
Group II - Cohort 5
American Barrick is the largest gold producer in North America. The implementation of the gold-hedging program differentiated the firm from other major gold rivals and improved its reserve and financial strength. In 1995, American Barrick ’s latest gold find necessitated the company to determine a new hedge strategy for its gold production.
I. Motivation
From the Exhibit 3, we find that few gold producers hedge their productions. Except the American Barrick, who hedged 94% of its 1992 production, other gold producers hedged only a small portion or none of their productions, therefore their gold’s mine sole output, and hence its profits, cash flows, and stock price were tied to gyrations in the price of gold[1]. In our opinion, the two reasons for gold-hedging program of American Barrick are:
1. Most of the gold producers would like to capture the full benefit of increases in the price of gold. They bet on the price of gold would go up in long term.
2. Gold is precious and easy to store, so most producers would like to store gold and sell it at a relatively high price. If the price of gold is lower than the producers’ expectation, they can store the gold with almost zero cost. This strategy is based on the low cost of gold storage and high liquidity of gold.
Compared to most gold producers, American Barrick operates more conservatively, which is the reason why it chooses to hedge most of its productions. Mr. Munk, the chief executive officer of American Barrick, emphasized the importance of having a strong, liquid balance sheet in the 1991 letter to shareholders.
In order to hedge the risk from gold price, the company has to give up the potential profit from the increase of gold price, because if the