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American Barrick American Barrick Resources Corporation Resources Corporation

(ABX)(ABX)

Managing Gold Price RiskManaging Gold Price Risk

FINA 6335 Risk ManagementFINA 6335 Risk Management

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Typical Gold Hedging ProgramTypical Gold Hedging Program It takes many years to extract gold from a It takes many years to extract gold from a

mine. By the time the mine is producing mine. By the time the mine is producing the price of gold will have changed.the price of gold will have changed.

A gold mining company will estimate the A gold mining company will estimate the ounces they will produce from a mine and ounces they will produce from a mine and then determine the time it will take to then determine the time it will take to exact this gold.exact this gold.

They then enter into short futures or They then enter into short futures or forward contracts to lock in the price that forward contracts to lock in the price that will be received.will be received.

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American Barrick CorporationAmerican Barrick Corporation Hedging activities;Hedging activities;

• Originally they entered into forward contractsOriginally they entered into forward contracts• They then entered into options.They then entered into options.• Next they used spot deferred contacts.Next they used spot deferred contacts.

ABX used virtually every instrument ABX used virtually every instrument available to manage its gold price risk.available to manage its gold price risk.

ABX creates imperfect hedges; they do ABX creates imperfect hedges; they do not completely neutralize their potential not completely neutralize their potential for upside profits; and definitely are in a for upside profits; and definitely are in a position to profit when prices of gold fall.position to profit when prices of gold fall.

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Hedging PolicyHedging Policy

Barrick’s board mandated a hedging Barrick’s board mandated a hedging policy:policy:

Fully protected for all production out Fully protected for all production out 3 years.3 years.

20%-25% protected for the following 20%-25% protected for the following decade.decade.

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In the absence of a hedging program using In the absence of a hedging program using financial instruments, how sensitive would financial instruments, how sensitive would Barrick stock be to gold price changes?Barrick stock be to gold price changes?

Without a hedging program Barrick’s stock price Without a hedging program Barrick’s stock price would be very sensitive to the fluctuations in gold would be very sensitive to the fluctuations in gold prices.prices.• If the gold price rose so would the stock price. If the gold price rose so would the stock price. • If the gold price falls so would the stock price.If the gold price falls so would the stock price.

Some gold mining companies do not hedge at all; Some gold mining companies do not hedge at all; this is publically announced and the investors can this is publically announced and the investors can buy these company stocks and reap the rewards buy these company stocks and reap the rewards of rising gold prices.of rising gold prices.

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For every 1% change in gold prices, For every 1% change in gold prices, how might it’s stock be affected?how might it’s stock be affected?

The performance of gold bullion is often The performance of gold bullion is often compared to stocks. compared to stocks.

They are fundamentally different asset They are fundamentally different asset classes: gold is a store of value whereas classes: gold is a store of value whereas stocks are a return on value (i.e. growth stocks are a return on value (i.e. growth plus dividends). plus dividends).

A 1% change in gold would create a 1% A 1% change in gold would create a 1% change in the stock price for ABX if they change in the stock price for ABX if they did not hedge.did not hedge.

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Dow Jones Industrial Average divided by the price of an Dow Jones Industrial Average divided by the price of an ounce of gold. ounce of gold.

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How could the firm manage its gold How could the firm manage its gold price exposure without the use of price exposure without the use of financial contracts?financial contracts?

The price of gold is fairly stable due to the costs The price of gold is fairly stable due to the costs associated with extracting the gold. associated with extracting the gold.

Supply Chain ManagementSupply Chain Management• By creating long term relationships with the equipment, By creating long term relationships with the equipment,

suppliers, and services that are needed, and to obtain suppliers, and services that are needed, and to obtain them dependably through long term supply arrangements.them dependably through long term supply arrangements.

Continuous ImprovementContinuous Improvement• Make equipment and supplies last longer; raise operating Make equipment and supplies last longer; raise operating

efficiencies. efficiencies. • Its an ongoing process, involving multi-disciplinary teams; Its an ongoing process, involving multi-disciplinary teams;

company creates best practices that are copied by other company creates best practices that are copied by other mines.mines.

• Using technology to improve efficiency and reduce costs.Using technology to improve efficiency and reduce costs.

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What is the stated intent of ABX’s What is the stated intent of ABX’s hedging program?hedging program?

Hedging program mandated by the board.Hedging program mandated by the board.• Fully protected for all production out 3 years.Fully protected for all production out 3 years.• 20%-25% protected for the following decade.20%-25% protected for the following decade.

ABX’s hedging program intentABX’s hedging program intent• To manage the firms exposure to gold price risk.To manage the firms exposure to gold price risk.• In an environment of falling gold prices; Barrick would In an environment of falling gold prices; Barrick would

profit.profit.• In an environment of rising gold prices; Barrick would In an environment of rising gold prices; Barrick would

profit to a mutually acceptable amount.profit to a mutually acceptable amount.• Finanical conservatism was to moderate although not Finanical conservatism was to moderate although not

completely eliminate, Barrick’s exposure to gold price completely eliminate, Barrick’s exposure to gold price risk.risk.

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What should be the goal of a gold mine’s What should be the goal of a gold mine’s price risk management program?price risk management program?

It depends on the firm. Some will not want to It depends on the firm. Some will not want to hedge at all, some will hedge partially, and some hedge at all, some will hedge partially, and some will try and totally reduce their risk 100%. will try and totally reduce their risk 100%.

In my opinion Barrick’s hedging policy is perfect. In my opinion Barrick’s hedging policy is perfect. They have maintained a strong stock price and They have maintained a strong stock price and have reaped the benefits of surges in gold prices.have reaped the benefits of surges in gold prices.

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Evolution of ABX’s Hedging ProgramEvolution of ABX’s Hedging ProgramIn

novati

on

Time

Gold Financing

Forward Sales

Option-Based Insurance

Spot Deferred Contracts

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Gold FinancingGold Financing

ADVANTAGESADVANTAGES No debt involvedNo debt involved

Low funding costLow funding cost

Royalties increase Royalties increase only if price only if price increasesincreases

DISADVANTAGESDISADVANTAGES Sacrifice profits Sacrifice profits

when price peakswhen price peaks

““Lien” on outputsLien” on outputs

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Forward SalesForward Sales

ADVANTAGESADVANTAGES No debt involvedNo debt involved

Guaranteed Guaranteed premium premium (contango)(contango)

Protect against Protect against falling pricesfalling prices

DISADVANTAGESDISADVANTAGES Sacrifice profits Sacrifice profits

when price peakswhen price peaks

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Option Based InsuranceOption Based Insurance

ADVANTAGESADVANTAGES No debt involvedNo debt involved

Protect against Protect against falling pricesfalling prices

Benefit when price Benefit when price peakspeaks

DISADVANTAGESDISADVANTAGES Few market playersFew market players

Short term horizonShort term horizon

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Spot Deferred ContractSpot Deferred Contract

ADVANTAGESADVANTAGES No debt involvedNo debt involved

Protect against falling Protect against falling pricesprices

Benefit when price Benefit when price peakspeaks

Long term horizonLong term horizon

DISADVANTAGESDISADVANTAGES Greater RiskGreater Risk

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Questions?Questions?