Due November 1, 2012
Presented By: Justin Merow on November 11, 2012
The following case study reports on a highly successful gold mining company, American Barrick Resource Corporation. We discuss herein the many of the techniques being used in their hedging programs and the variation between such programs. The company itself was founded by a gentleman named Peter Munk, who was a successful Canadian entrepreneur and had come to American Barrick with no prior experience in the gold-mining business. That being said, the company grew from an equity capitalization of $46 million to about $5 billion, its annual production grew from 34,000 ounces to 1.325 million ounces, and its proven and probable resources grew from 322,000 ounce to nearly 26 million ounces, all between the years of 1983 and 1992. American Barrick was both fast and profitable, with its profitability coming from many sources, despite a decline in gold prices. The company acquired its gold mines for relatively low prices, and later found reserves in Goldstrike that enabled its scale of economies. During this case, we determine how American Barrick should handle the unexpected production from the Meikle Mine, the development of its hedging programs over time, the financial instruments of those programs, and how these hedging programs contributed to American Barrick’s superior performance.
As producers of commodity products, gold-mining firms had virtually no marketing or distribution costs. There was always a ready market for their product, at market price, once extracted from the earth and refined. Therefore, the profits were a function of the quantity of its production and the difference between the prices at which it sold its output and its costs. Gold producers operated having four main phases: Exploration: Competitive advantages can be viewed as mines with gold closer to the surface, mines with ores richer in gold, and mines with ore in physical forms more amenable to recovery have natural cost advantages over others. A gold producer gains a competitive advantage based on the physical features of the ores, and, therefore, can have an advantage if their exploration techniques allow them to determine gold quantities (rough estimation) before the actual excavation takes place. Acquisition: Gold mines also needed large fixed or sunk costs. The geology and economics of gold mining required firms to invest large sums of money to create infrastructure needed to be able to dig and process the ore. A gold producer gains a competitive advantage based on the number of ores that it owns, as having more ores increases the likelihood of obtaining one of these spoken-of ‘natural advantages’. Develop Mine Process: It is industry standard that large amounts of ore must be mined and then processed in order to extract very small amounts of gold. To point, the ore in American Barrick’s Goldstrike Mine contained an estimated .127 ounces of gold for each ton of ore, meaning that to produce a single ounce of gold that might sell for $300-400, American Barrick would need to mine and process about 16,000 pounds of rock. Once mined, the ore would be treated by processes including crushing the ore, heating the ore, sorting by density, chemically treating it, and finally refining to remove impurities. A competitive edge might be found in the technological benefits of gold mining tools being used. For instance having a tool that can mine gold at a faster rate would be an advantage over more commonly used tools. Sell gold: As producers of commodity products, gold-mining firms had virtually no marketing or distribution costs. There was always a ready market for their product, at market prices, once taken from the earth and refined. A gold mine’s profits were a function of the quantity of its production and the difference between...