Silver Stock Report
by Jason Hommel, February 25, 2008
Since my email on Feb 23, Barrick Gold has made it easier to find information about their gold hedge book liability.
They updated their website, and replaced the link at the bottom of the page here:
http://www.barrick.com/Investors/HedgePosition/default.aspx
Now, the link goes directly to an excerpt from the recent quarterly report:
http://www.barrick.com/Theme/Barrick/files/Project%20Gold%20Sales%20Contracts.pdf
Barrick is to be commended for making this information more accessible, so we can see the bad position they are in.
On page 34, they note: “we have 9.5 million ounces of existing gold sales contracts specifically allocated to these projects.”
On page 35, they note: “Based on closing spot price of $913 per ounce on February 15, 2008, the mark-to-market liability is $(5,095) [in millions].”
This is slightly less than the $6 billion loss based at a spot price of $950/oz. that I estimated yesterday, based on older estimates from the company.
Since Barrick Gold only has $2.2 billion in cash, and $1.1 billion in annual earnings, it could be some time before this hedge could be lifted, because they don’t have the cash to eliminate it today. If they tried to buy back the gold today, they would have to come up with the “mark to market liability” of over $5 billion.
But Barrick Gold does not plan to deliver these ounces until 2011, 3 years from now. There could be a big problem if their project mine, Pascua Lama, which has been a project for over 7 years now, does not get built.
As Antal Fekete has noted, Barrick could have purchased offsetting call options to reduce the ever increasing exposure to a rising gold price; and that would be far cheaper than buying back the entire hedge. I wonder how high the gold price will be, 3 years from now, and I wonder how much that will cost Barrick Gold and their shareholders.
I think it is rather shameless and deceptive for company president and chief executive, Greg Wilkins, to speak as if higher gold prices are good for Barrick Gold, while having 9.5 million ounces of gold on the hedge book which exposes Barrick to nearly unlimited losses as gold prices continue to rise.
Furthermore, Barrick Gold has promoted itself has having “no company hedges;” which is extremely deceptive because the company does have hedges on several projects. It seems as if “company hedges” must be a technical term used to differentiate between “project hedges”, but who in the general public, and who among TV commentators that Barrick Gold takes advantage of, will know that the word “company” is a technical term that means the opposite of “project”?
Barrick should quit playing games with words, and move aggressively to close out their rising hedge liability, or at least hedge it with options!
Another industry practice that is highly deceptive (besides being less than clear about gold hedges and their losses) is cash costs.
Cash costs only include operating costs of a pre-built mine.
Cash costs do not include:
Exploration, which includes things such as prospecting, staking, claims fees, air surveys, ground surveys, drilling, mapping, 3d modeling & resource calculations, etc.
Development, which includes things such as environmental impact studies, engineering studies, feasibility studies, and mine construction capital costs, etc.
Administration, which includes things such as office space, accountants, lawyers, annual reports, trips to mining shows, litigation expenses, share listing expenses, entertainment, emergency web site updates, commissions and premiums for acquisitions, and hedge book losses, etc.
In a rising metals market, the best way to purchase protection from downside movements is not to sell the metals short like Barrick Gold did, but rather, to buy puts. Puts give the holder the right, but not the obligation, to sell at a set price. Thus, with puts, there are not continuing losses in case the metals prices continue to rise.
(You can also sell “out of the money” puts below the market prices for metals, so that the market automatically sells to you on the dips. And if they don’t, you just keep the premium from selling the puts.)
A few months ago, I advocated that Baja Mining buy the lowest price puts needed to maintain profitability of their copper project. I would estimate that Baja could buy puts with the right to sell copper at about $1.25/lb, which would fully protect the company in case copper prices moved down, and these could be purchased for less than $10 million (I’d sell them to them, as I’d love to collect the $10 million for doing nothing), and this would also protect against the dangers of short selling which could cause multi-billion dollar losses in case copper prices continued to go up in an environment of runaway inflation.
Since then, I’ve not heard any mention from Baja about the hedge terms required by the terms of their loan. I think borrowing money, and paying a commission out, as Baja did, without setting the terms of their hedges, ought to be criminal. After all, what if I told you that I bought a house, and got a loan, and even paid the loan officer their fee, but still didn’t know what the interest rate on my loan was? You’d think that was ridiculous, but the mining companies have gotten away with doing just that! The companies will probably continue to get away with such games as long as nobody bothers to sue them; but who would bother except the largest shareholders, most of whom probably still don’t understand these issues, and who probably wouldn’t want the negative publicity to hurt their investment! In December, Baja appointed a new Chief Financial officer, but still has not announced any hedging terms.
http://biz.yahoo.com/iw/071212/0339275.html
Although Baja Mining is probably a good investment, a better investment would be to sell them the puts that they claim that they need, but don’t really need. It would be like collecting a fat insurance premium for a disaster that would never come.
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A different mining company, one that I own, that recognizes the strategic nature of their natural resources, located within the USA, has done it well. They avoided short selling. And instead, they bought puts, and announced the terms clearly, giving them the right, but not the obligation, to sell at set zinc prices of $1.20/lb. And they avoided buying too much of these financial instruments, only enough for six months; doing the bare minimum to cover the debt for mine financing, which could probably be paid back in 6 months to a year. As they have just begun producing, I and my team estimate that they have a forward P/E ratio of 1.3, with a market cap of $84 million, $94 million fully diluted if you include the options and warrants. Their primary mineral is zinc, with two other by-product minerals you probably never heard of.
The company’s stock price is not likely to go up by a factor of 10, but I think you could make at least a hundred percent or a few hundred percent return fairly quickly within a year or two with little risk, and that’s more than enough for a serious look. The stock trades about $140,000 worth of stock per day.
With leverage to zinc, if the zinc price improves, as I expect it will, the prospects for this stock get much better.
I would have most preferred if this company recognized more fully the benefits of the free market, and engaged in advertising the benefits of their company more widely to the market, by engaging in active marketing–and then, with a higher stock price, raised the needed money by issuing stock– and avoiding the cost of buying puts altogether, and trusting in the free market price of zinc. But as it is, their lack of foresight to effectively market their stock, creates the opportunity for me to invest, and share this company with you, as I stand to gain if this stock goes up more quickly than it otherwise would, through the help of my own marketing efforts. (And they now stand to gain by getting free advertising.) But I don’t mind such charity work, because I’m an evangelist!
And thus, the market creates a built in incentive for people who could copy my rather simple business model, to tell the truth. The market also rewards those who go looking for truth, and recognize truth, and act on truth.
The beauty of what I do, is that there are no trade barriers to it. Anyone, if they prepared themselves by doing enough research and ongoing research into stocks and the nature of marketing, and worked hard enough at it, could do what I do. And let me tell you, the rewards are good, because so many people are helping me for free, helping me to find the absolute best companies in the world, it’s a greater blessing that I could have imagined when I started!
Sincerely,
Jason Hommel