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Gold Mining Industry Cindy Chen Julia Lee Weiwei Sun Patrick Tan Johanne Lee Gold Mining Industry Overall Introduction Structure of Industry Financial Structure Risk Assessment Regulatory Environment (FASB) Overall Introduction Major Product GOLD Substitutes Direct Substitutes

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gold mining industry

Gold Mining Industry

Cindy Chen

Julia Lee

Weiwei Sun

Patrick Tan

Johanne Lee

gold mining industry2
Gold Mining Industry
  • Overall Introduction
  • Structure of Industry
  • Financial Structure
  • Risk Assessment
  • Regulatory Environment (FASB)
overall introduction
Overall Introduction
  • Major Product

GOLD

  • Substitutes
    • Direct Substitutes
    • Indirect Substitutes
      • Blooming economic condition
production process tech
Production Process (Tech.)

Exploration

Exploration Drilling

Open Pit Mining

Blasting

Underground Mining

Ore and Waste Haulage

production process tech5
Production Process (Tech.)

Heap leaching

Oxidization

Milling

Leaching

Stripping

Electro-winning

production process tech6
Production Process (Tech.)

Smelting

Gold Bullion

Refining

Reclamation

structure of industry
Structure of Industry
  • Market Dynamics:
    • Gold price change
recent change in gold price
Recent Change in Gold Price
  • Year 2000 – present
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

Structure of Industry (cont’d)
  • Major companies (selected by assets)
financial structure
Financial Structure
  • Cost Structure
    • Exploration, research and development
    • General operation costs
    • Depreciation, depletion and amortization
    • Interest expenses
    • Write-down of assets
    • Other
financial structure11
Financial Structure
  • Revenue Composition
    • Mining revenue
    • Interest income revenue
    • Financial activities revenue (ie. Hedging)
risk assessment
Risk Assessment
  • Nature of Mineral Exploration and Mining
  • Environmental Risks
  • Reserve Estimates
  • Worldwide Operations
  • Licenses and Permits
risk assessment cont d
Risk Assessment (cont’d)
  • Interest Rate Risk
  • Foreign Exchange Rate Risk
  • Commodity Price Risk
  • Derivative Instrument Risk

- Credit risk

- Market liquidity risk

- Mark-to-market risk

  • Energy Risk
risk management strategies
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
fasb 133
FASB 133
  • Requires companies to recognize all derivatives instruments as assets or liabilities in the financial statements
  • Measured at fair market value
  • Classification of hedges:
    • Fair Value Hedge
    • Cash Flow Hedge
    • Currency Hedge
    • Non hedging derivatives
corporate profile
Corporate Profile
  • Entered Gold Mining Business in 1983
  • Has operations in the United States, Peru, Tanzania, Chile, Argentina, Australia and Canada
  • Proven and probable mineral reserves of 86.9 million ounces of gold
hedging philosophy
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.
hedge position
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
risk exposures
Risk Exposures
  • Gold and Silver Price Risk
  • Interest Rate Risk
  • Foreign Exchange Risk
  • Derivative Risk
    • Credit Risk
    • Market Liquidity Risk
    • Mark-to-Market Risk
hedge position22
Hedge Position

Current hedge position

Financial Statements Tour

hedging instruments
Hedging Instruments
  • Spot deferred forward Contracts (90%)
  • Variable price Contracts
  • Options
spot deferred contract
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.
spot deferred contract features
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.
spot deferred contract features26
Spot Deferred Contract: Features

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)
how it works
How It Works

Bullion Bank

Central Bank

Barrick

Barrick enters into the spot deferred contract with the Bullion Bank.

slide28
How It Works

Bullion Bank

Central Bank

Barrick

Bullion Bank borrows gold from the Central Bank

how it works29
How It Works

Bullion Bank

Central Bank

Barrick

Spot Market

Sells the gold in the spot market

how it works30
How It Works

Bullion Bank

Central Bank

Barrick

1% lease rate

Interest earned 4%

how it works31
How It Works

Bullion Bank

Central Bank

Barrick

At the delivery date Barrick delivers the gold

how it works32
How It Works

Bullion Bank

Central Bank

Barrick

Bullion Bank pays Barrick and returns the gold to the Central Bank

problems
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
newmont mining corporation

Newmont Mining Corporation

Creating Value with Every Ounce…

corporate profile35
Corporate Profile
  • Incorporated in 1921
  • Other 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
creating value with every ounce
Creating Value with Every Ounce…
  • Growing reserves
  • Strengthening asset base
  • Increasing earnings per share
  • Paying higher dividends
  • Improving financial strength
gold sales
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
hedging philosophy38
Hedging Philosophy
  • A non-hedger
  • Viewing gold as an equivalent to money
  • Creating paper gold is considered too risky
risk exposures39
Risk Exposures
  • Commodity Price Risk
  • Foreign Exchange Risk
  • Interest Rate Risk
commodity price risk
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
foreign exchange risk
Foreign Exchange Risk
  • Subject to local currency exchange rates against the US dollars
    • A devaluation of local currency is neutral or beneficial, and vice versa
  • Currency 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
interest rate risk
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

hedge position43
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
financial highlights
Financial Highlights

In 2002:

  • At an average realized gold price of $313 per ounce
  • Sold 7.6 M ounces of gold
  • Revenue of 2,745 million
  • Net cash of 670.3 million
financial highlights48
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
kinross gold corporation

Kinross Gold Corporation

“Timing is Everything”

corporate profile50
Corporate Profile
  • Formed in 1993
  • The 7th largest primary gold producer in the world
  • Highly leveraged to changes in the price of gold
  • A strict non-hedger (approximately 3.5% of reserves hedged falling to zero by early 2005)
  • Majority of production in North America
  • Highest beta to bullion responses in a rising gold price environment
operating highlights
Operating Highlights
  • 888,634 gold equivalent ounces
  • Total cash cost US$201 per ounce
  • Net Loss per share US$0.32
  • Cash flow provided from operating activities US$0.53 per share
risk exposures52
Risk Exposures
  • Commodity Price Risks
  • Foreign Currency Exchange Risk
  • Interest Rate Risk
  • No Speculative or Trading Purposes
commodity price risks
Commodity Price Risks

Financial instrument in use:

  • Spot deferred contracts
    • 312,500 ounce @ $280
  • Fixed forward contracts
    • Unknown
  • Written call options
    • 150,000 ounces @ $326
    • Recorded in the financial statements at each measurement date.
foreign exchange risk54
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
interest rate risk55
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
energy price risk
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
fair values of instruments57
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
financial loss
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)
comparison
Comparison
  • Risk Management Philosophy
recommendation barrick
Recommendation: Barrick
  • To maintain its current hedge book
  • In-line with its hedging philosophy
  • Not cave in to shareholder pressure
recommendation newmont
Recommendation: Newmont
  • To keep reducing its hedge book to zero
  • In-line with its non-hedging philosophy
  • Not creating paper gold and thus fluctuating gold prices
recommendation kinross
Recommendation: Kinross
  • To remain as a non-hedging firm
  • Since Kinross is small in size, relative to others, one way to attract investor is to offer higher beta to bullion price
empirical studies on hedging in gold mining industry
Empirical Studies on Hedging in Gold Mining Industry
  • Investors value volatility when it comes to gold mining stocks
  • The more a firm hedges gold price risk the worse it is for their stock return
  • Gold 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”

conclusion
Conclusion
  • Overall, a decreasing trend on hedging position is observed
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