gold mining industry cindy chen julia lee weiwei sun patrick tan johanne lee
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Gold Mining Industry
Cindy ChenJulia Lee
Weiwei SunPatrick Tan
Johanne Lee
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Gold Mining Industry
Overall IntroductionStructure of IndustryFinancial StructureRisk AssessmentRegulatory Environment (FASB)
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Overall Introduction
Major ProductGOLD
Substitutes–Direct Substitutes–Indirect Substitutes
•Blooming economic condition
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Production Process (Tech.)
Exploration Exploration Drilling Open Pit Mining
Blasting Underground Mining Ore and Waste Haulage
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Production Process (Tech.)
Heap leaching Milling Oxidization
Leaching Stripping Electro-winning
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Production Process (Tech.)
Smelting Gold Bullion
Reclamation
Refining
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Structure of Industry
Market Dynamics:– Gold price change
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Recent Change in Gold Price
Year 2000 – present
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Structure of Industry (cont’d)
– Barrick Gold Corp.
– Newmont Mining
– Kinross Gold Corp.
– Meridian Gold– Agnico-Eagle Mines – Glamis Gold – Goldcorp Inc. – Cambior Inc. – Ivanhoe Mines– Placer Dome
•Major companies (selected by assets)
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Financial Structure
Cost Structure– Exploration, research and development– General operation costs– Depreciation, depletion and amortization – Interest expenses– Write-down of assets – Other
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Financial Structure
Revenue Composition– Mining revenue– Interest income revenue– Financial activities revenue (ie. Hedging)
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Risk Assessment
Nature of Mineral Exploration and MiningEnvironmental RisksReserve EstimatesWorldwide OperationsLicenses and Permits
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Risk Assessment (cont’d)
Interest Rate RiskForeign Exchange Rate RiskCommodity Price RiskDerivative Instrument Risk - Credit risk
- Market liquidity risk - Mark-to-market risk
Energy Risk
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Risk Management Strategies
Use of derivatives on commodities– Hedging on Gold
Use of derivatives or other financial instruments on non-commodity items– Not Hedging on Gold– On fuel, interest rate and foreign exchange rate
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FASB 133
Requires companies to recognize all derivatives instruments as assets or liabilities in the financial statements
Measured at fair market valueClassification of hedges:
– Fair Value Hedge– Cash Flow Hedge– Currency Hedge– Non hedging derivatives
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BARRICK Gold Corporation
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Corporate Profile
Entered Gold Mining Business in 1983Has operations in the United States, Peru,
Tanzania, Chile, Argentina, Australia and Canada
Proven and probable mineral reserves of 86.9 million ounces of gold
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Hedging Philosophy
Creates stable, predictable returns regardless of short-term market conditions.
De-linking Barrick's earnings from the volatility in the spot gold market.
Creates additional cash reserves that can be used to acquire new assets to accretive to earnings.
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Hedge Position
Barrick hedges approximately 18% of its gold reserves. – 16.1 million ounces or 3 years of expected
future production
Between 1991 and 2002, Barrick's forward sales program allowed the company to generate additional revenue of $2.2 billion
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Risk Exposures
Gold and Silver Price Risk Interest Rate Risk Foreign Exchange Risk Derivative Risk
a) Credit Risk
b) Market Liquidity Risk
c) Mark-to-Market Risk
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Hedge Position
Current hedge position
Financial Statements Tour
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Hedging Instruments
Spot deferred forward Contracts (90%)Variable price ContractsOptions
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Spot Deferred Contract
The spot deferred contract is a commitment by the producer to deliver a fix amount of gold to the contract counterparty at a time in the future at a fixed price.
The forward price of the contract is based on the spot price on the date of the contract plus a premium (contango).
The contango is the difference between the LIBOR less the gold lease rate.
The difference between a spot deferred contract and a simple forward contract is that the spot deferred contract can be rolled over into a new contract on delivery date.
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Spot Deferred Contract: Features
The counterparties do not have unilateral and discretionary ‘right to break’ provisions.
There are no credit downgrade provisions. Barrick is not subject to any margin calls –
regardless of the price of gold. Barrick has the right to accelerate the delivery of
gold at any time during the life of its contracts. This flexibility is demonstrated by the terms that allow Barrick to close out hedge contracts at any time on two days notice.
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Barrick’s trading agreement also specifies that the counter parties can opt for early close out of their contracts in the event of:
a material and lasting impact on Barrick’s ability to deliver gold
the counterparties being unable to borrow gold to facilitate the forward contracts
Barrick having a net worth of less than $2 billion (currently 3.2 billion)
Barrick having a debt to net worth ratio of more than 1.5-2.0:1 (currently 0.25:1)
Spot Deferred Contract: Features
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How It Works
Barrick
Bullion Bank
Central Bank
Barrick enters into the spot deferred contract with the Bullion Bank.
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Barrick
Bullion Bank
Central Bank
Bullion Bank borrows gold from the Central Bank
How It Works
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How It Works
Barrick
Bullion Bank
Central Bank
Spot Market
Sells the gold in the spot market
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BarrickCentral Bank
Interest earned 4%
Bullion Bank
1% lease rate
How It Works
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BarrickCentral Bank
Bullion Bank
At the delivery date Barrick delivers the gold
How It Works
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Barrick
Central Bank
Bullion Bank
Bullion Bank pays Barrick and returns the gold to the Central Bank
How It Works
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Problems
Barrick faces huge opportunity losses should gold prices increase
If gold lease rate rises above the Libor rate then forward prices will be in backwardation
If Barrick’s counterparties are not able to borrow gold to facilitate the contract Barrick can be forced to deliver gold at an unfavourable price
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Newmont Mining Corporation
Creating Value with Every Ounce…
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Corporate Profile
Incorporated in 1921Other than gold, also engages in the
production of and exploration for silver, copper and zinc
Has operations in North America, Canada, Australia, New Zealand, Indonesia, Uzbekistan and Turkey
Owns 86.9 million equity ounces of gold
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Creating Value with Every Ounce…
Growing reservesStrengthening asset baseIncreasing earnings per sharePaying higher dividendsImproving financial strength
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Gold Sales
Gold sales are made at the average price prevailing during the month, in which the gold is delivered to the customer, plus a "contango“
Revenue is recognized when the price is determinable upon delivery with title transferred to the customer
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Hedging Philosophy
A non-hedgerViewing gold as an equivalent to moneyCreating paper gold is considered too risky
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Risk Exposures
Commodity Price RiskForeign Exchange RiskInterest Rate Risk
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Commodity Price Risk
Metal prices fluctuate– Due to demand, forward selling by producers,
central bank sales, purchases and lending, investor sentiment, and global mine production levels
Forward sales contracts with fixed and floating gold lease rates
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Foreign Exchange Risk
Subject to local currency exchange rates against the US dollars– A devaluation of local currency is neutral or
beneficial, and vice versaCurrency swap contracts
– To hedge the currency risk on repayment of US$-denominated debt
Cross currency swap contracts– To receive A$ and pay US$ – Designated as hedges of A$-denominated
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Interest Rate Risk
Interest rate swap contracts Against the interest rate risk exposure from
bonds, notes, debentures, and other debts– A reduction in interest expense of $5.9 M
in 2002
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Hedge Position
Currently working to eliminate the hedge book inherited from the acquisition of Normandy– Hedging 80~95% of total reserves
About 10.3% of Newmont's proven and probable reserves were subject to derivative contracts
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Fair Values of Instruments
Gold CommodityContracts
Ounces (000)
Fair Value (000)
Gold Forward Sales Contracts 3,332 (209,717)
Gold Put Option Contracts 1,544 (22,603)
Gold Convertible Put Options 1,459 (125,486)
Gold Sold Convertible Put Options
240 (14,295)
Price-Capped Contracts 377 n/a
US$/Gold Swap Contracts 600 (87,200)
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Fair Values of Instruments
Other Sales Contracts, Commodity and Derivative Instruments
Fair Value (000)
Cross Currency Swap Contracts (8,500)
Currency Swap Contracts (21,924)
Interest Rate Swap contracts 13,800
Fixed Rate Debt 1,075
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Annual Report 2002
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Financial Highlights
In 2002:At an average realized gold price of $313
per ounceSold 7.6 M ounces of goldRevenue of 2,745 millionNet cash of 670.3 million
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Financial Highlights
Cash Flow Hedges– Accumulated Other Comprehensive Income (Loss) of
(54.6M) – Gain (Loss) on Derivative Instruments of (39.8M)
Under Financial Statement Interest Swaps
– Interest, Net of Capitalized Interest is recorded as an expense of 129.6M
Foreign Currency Exchange Contracts– Dividend, Interest, Foreign Currency Exchange and
Other Income of 39.8M
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Kinross Gold Corporation
“Timing is Everything”
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Corporate Profile
Formed in 1993The 7th largest primary gold producer in the
worldHighly leveraged to changes in the price of goldA strict non-hedger (approximately 3.5% of
reserves hedged falling to zero by early 2005)Majority of production in North AmericaHighest beta to bullion responses in a rising gold
price environment
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Operating Highlights
888,634 gold equivalent ouncesTotal cash cost US$201 per ounceNet Loss per share US$0.32Cash flow provided from operating
activities US$0.53 per share
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Risk Exposures
Commodity Price RisksForeign Currency Exchange Risk Interest Rate RiskNo Speculative or Trading Purposes
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Commodity Price Risks
Financial instrument in use:Spot deferred contracts
– 312,500 ounce @ $280Fixed forward contracts
– UnknownWritten call options
– 150,000 ounces @ $326– Recorded in the financial statements at each
measurement date.
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Foreign Exchange Risk
Financial instrument in use:Foreign exchange forward contracts
– Sell U.S. dollars and buy Canadian dollars– CDN $25.8 million at an average exchange
rate of 1.5175– Mature over a 12 month period
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Interest Rate Risk
Financial instrument in use:Interest rate swaps
– There are no interest rate hedging transactions outstanding as at December 31, 2002.
– Probably due to lax monetary policy
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Energy Price Risk
Financial instrument in use:Crude oil forward purchase contracts
– As at December 31,2001– Buy 28,500 barrels of crude oil forward at a
price of $20.83 per barrel.– No hedging agreements in place
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Fair Values of Instruments
In 2002:$20.3 million recorded as loss on forward
contract$0.8 million recorded as loss on foreign
currency contracts
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Financial loss
Loss incurred from Interest and other income– $65.6 million
Share in loss of investee companies– $12.9 million
Mark-to-market loss on call options– $2.7 million (pg 88)
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Comparison
Risk Management Philosophy
Barrick De-linking Barrick's earnings from the volatility in the spot gold market.
Newmont non-hedging philosophy
Kinross non-hedging philosophy
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Recommendation: Barrick
To maintain its current hedge bookIn-line with its hedging philosophy Not cave in to shareholder pressure
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Recommendation: Newmont
To keep reducing its hedge book to zeroIn-line with its non-hedging philosophyNot creating paper gold and thus
fluctuating gold prices
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Recommendation: Kinross
To remain as a non-hedging firmSince Kinross is small in size, relative to
others, one way to attract investor is to offer higher beta to bullion price
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Empirical Studies on Hedging in Gold Mining IndustryInvestors value volatility when it comes to
gold mining stocksThe more a firm hedges gold price risk the
worse it is for their stock returnGold mining firms that aggressively hedge
gold price are not maximizing shareholder value
~~Matthew Callahan, “To hedge or not to hedge…from the North American gold mining industry”
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Conclusion
Overall, a decreasing trend on hedging position is observed
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Any Questions?