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.
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. 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 company perfectly hedges its risk exposure, the profit is locked whatever the risk finally. When company steps into a derivative market to hedge its risk, the premium paid for broker, option seller and other media is inevitable. Thus there is cost for hedge. American Barrick uses different kinds of vehicle to hedge the gold price risk they face. These vehicles ranging from gold financings, forward sales, options strategies, and spot deferred contracts, make American Barrick gain bumper benefits when the gold market is prosperous and more eventfully, help the company retain profits in times of downturn.
American Barrick shed some of its gold price risk by using 4 different kinds of vehicles: gold financings, forward sales, options strategies and spot deffered contracts. For the gold financings, there are five ways adopted by American Barrick---common shares, Barrick-Cullation Gold Trust, bullion loans, gold-indexed Eurobond offerings and gold-indexed underwritten offerings---in which the bullion loans we think is most useful. Despite the price to get a bullion loan is to collateralize the company’s asset of mine, a price which would be very high since the company may go to bankruptcy if it fails to fulfill its commitment, yet, it allows the company to have much needed capital to make acquisitions of other mine asset which will in turn bring stupendous interests to the company. So, we see bullion loan as a good way for American Barrick to hedge the risk of lacking of urgent capital.
Forward sales have its merits. It allows the forward sellers receive a premium above the current gold price, which is equal to the difference between the interest rate for lending dollars and the interest rate fore lending gold. Here comes the problem. If the interest rates for lending slides while the one for lending gold climbs, then the contango, the difference between the two interests will be reduced. Besides, as the case of American Barrick’s selling forward...