American Barrick Resources Corporation

Managing Gold Price Risk

Gold
Demand
1. Jewelry (80%)
2. Commercial and
Industrial use
3. Back-up for currencies

Supply
1. Expanding Production
Soviet Union
South Africa
North America
Australia
2. Central Banks
Liquidation

Factors that may increase gold price:

1. Large government deficits
2. Financial and economic crisis
3. Wars and doomsday scenarios
4. Increase in gold jewelry demand ?
5. Commercial and Industrial demand ?
Factors that may decrease gold price:
1. Financial and economic stability
2. Trends towards democracy and free markets
3. Effective use of monetary policy by central banks
4. Liquidation by central banks

Long-term trend?

Should Gold Producers Hedge Gold Price

Risk?
Pros

Cons

1. Protect downside
1. Sacrifice Upside
2. Share price premium?
2. Unsystematic risk?
3. Specialize in gold production 3.Share price penalty?
not gold risk taking
4. High operating leverage
and high sunk costs
5. Limited ability to adjust production
6. Lock-in the low total costs (see exhibit 3)

Managing Gold Price Risk The Evolution

1. Gold Financing
Barrick-Cullaton Gold Trust
Bullion loans (denominated in gold e.g., to finance
Goldstrike mine)
Gold-indexed Eurobond offerings
The main disadvantage
Conservative financial policy limits the amount of loans
(see exhibit 3)
Interest cost is only a small portion of total costs

2. Forward Sales
Normal forward contract
FT = S (1 + i)T
Gold forward contract
FT = S (1 + i - g)T = S (1 + c)T
where c = i - g
c = contango rate
i = dollar interest rate
g = gold lease rate

The main disadvantages

1. Sacrifices the upside
2. Quantity produced must be known
1984-85 experience hedged at the wrong time

3. Put Options and Warrants

The main advantages
1. Does not sacrifice the upside
2. Quantity produced doesnt have to be known exactly
Variations:
The collar Strategy
Buy puts (with a low exercise price) financed by
writing calls (with a high exercise price).
Example Buy a put at $420 per ounce
Write a call at 550 per ounce
Or,

Buy a put at $420 per ounce

Write 0.5 calls at 485 per ounce

See exhibit 11
The main disadvantages
1. Option contracts of maturities longer than 5 years
unavailable
2. Market was illiquid for maturities longer than 2 years.

4. Spot Deferred Contracts

1. Like a forward contract but allows delivery at the
chosen dates by the seller of the forward contract.
2. The forward prices are given as:
FT = S (1 + c1)(1+c2)(1+c3)(1+cT)
Where S is todays Comex gold price and
ct (t = 1, 2,T) is the contango rate between time t 1
and t, prevailing at time t - 1.
3. If an SDC forward contract is written on 5 million
ounces of gold over five years, then the seller can decide
how much is to be delivered when but the entire 5 million
ounces should be sold over five years at the appropriate
forward prices.
4. Allows a minimum price (protects from downside
risk), and yet the advantage of temporary price upswings.
Can smooth earnings flow.
The main disadvantage:
If the gold price rises steadily forever, then the delivery
can only be postponed, but will have to be made at some
point in the future. However, the long-term trend in gold

price seems downward, so this may not be such a

disadvantage