Sell Barrick: A Sneaky Hedger!

(Barrick is losing money, and will cause you to lose money, too.)

Silver Stock Report

by Jason Hommel, February 23, 2008

Barrick Gold is sitting on an unrealized "mark to market" hedging loss of $6.165 billion, and the loss is growing.  They hedged 9.5 million oz. of gold at $296/oz. in "project" hedges.  With the gold price at $945/oz., they are losing about $649/oz. on the hedge.  $649 x 9.5 = $6.165 billion loss.  Barrick's loss grows by $950 million for every $100 increase in the gold price. 

I know, because I've been following this market for years.  Barrick makes this information very difficult to find, but I'll show you exactly where to find it.  The implications will be disastrous for Barrick as long as they hide this information from the market.  Barrick cannot close out the hedges by raising capital from the market by issuing stock, not as long as they continue to deceive the market, and market themselves as an "unhedged" producer. 

After I exposed Barrick yesterday, I figured it was time to more thoroughly re-evaluate Barrick's hedges, and company situation, and prove it every step of the way.  Not enough of my readers seemed to understand the importance of this.  This will be a great learning exercise and tutorial on stock investing.  I found the basic information very easily, at Yahoo! Finance.

Market cap: $43.58 Billion at $50.16/share. (Price)
P/E (The Price to Earnings ratio) is listed as: 43.85

Next, I went looking for proof of Barrick's hedge position, to see how many gold ounces they sold, and at what price.  First, I found the latest corporate presentation--I typically start there, because they summarize things easily and quickly.  I did not find anything on hedges, but I found some useful information.

2007 net income: $1.12 billion (Earnings)

Price to net income ratio: $43.58/$1.12 = 38.9

38.9 is somewhat less than Yahoo's P/E figures, but I figure it's close enough.

p. 5:
expected 2008 production: 7.6 - 8.1 million oz.
expected 2008 cash cost per oz.: $390-$415.

8 million oz. annual production x $500/oz. margin = $4 billion.  (This is larger than 2007 EBITDA, which was around $3 billion).  The difference between 3-4 billion could be the higher current gold price.  I was shocked to discover the low net income of $1.12 billion.

Next, I went looking for the latest quarterly report.  I found it at the top of the investor's section at the web site, under the link, "Annual & Quarterly Reports"; this is the "2007 Year-End Report"

I scanned through the entire 106 page report, twice, looking for information on the gold hedges.  Twice, the following tiny note jumped out at me, as the only information that might be related to gold hedges:

p. 31:  note 3: Derivative Liabilities - Amounts presented in the table relate to hedge contracts disclosed under notes 2 and 20 to the Financial Statements. Payments related to derivative contracts cannot be reasonably estimated given variable market conditions.  (!!!)

To me, it looks like they are trying to bury the information, by saying that it is not reasonable to calculate it, as if they cannot come to any real estimates, so they are not going to bother.

Information on gold hedges is non-existent in the 106 page "FOURTH QUARTER AND YEAR-END REPORT 2007, dated FEBRUARY 21, 2008"  I found that utterly shocking, and I was beginning to wonder if my statements yesterday had left me open to libel charges, and that I could be sued.  So, now I had to pursue it further.

At the investors page, there is a peculiar link called "Hedge Position"

This page is also deceptive because it says:

"Our operating mines are now completely unhedged."

Note, it says nothing about non-operating mines, such as projects, which are hedged!

If you follow the link at the bottom of that page that says, "Click Here for Further Information" you find a 6 page report called "Financial Strategy".

On p. 1:
As of February 2007, Barrick has 9.5 million ounces of Project Gold Sales Contracts, which have been allocated to facilitate the financing of our pipeline of projects, including Pascua-Lama, Pueblo Viejo, Donlin Creek, and Reko Diq.

Ah ha!  So, they come clean and admit "project" hedges! (But the information is certainly burried!)  However, further deceptive wording continues:

These contracts will provide price support for these future financings, and represent about 26% of Barrick’s 36 million ounces of undeveloped gold reserves.

How can locking in the gold price at about $350/oz. be called "price support" in this environment of rising gold prices?  Does Barrick really think gold prices are at risk to go below $350/oz.?  Again, that's very deceptive.  $350/oz. hedges are not "supportive" given the current price of $945/oz.!

p. 4:
Future estimated average realizable selling price $391/oz.(2)

Note that they don't list the average price of the gold hedges, instead, they call it a "Future estimated average realizable selling price".  Perhaps this is why they feel that they can get away with saying in the financial reports that it's not reasonable to calculate the loss.  Or perhaps it's the corporate culture these days, where the Securities and Exchange Commission is not requiring financial disclosures of derivatives of financial institutions such as JP Morgan, or Freddie Mac.

p. 4 again:
Mark-to-market value at
December 31, 2006 ($3,187) million(3)

Ah ha! They admit a $3.2 billion loss on the gold hedges (but that was over a year ago, when gold was cheaper).

/ 9.5 million ounces = a loss of $335/oz. per oz. gold. hedged.

Calculated at $632/oz. = $296/oz. average hedge price!

p. 4 continues to explain the average hedging price:

Under the Project Gold Sales Contracts, we have
an obligation to deliver gold by the termination date
(currently 2016 in most cases). However, because we
typically fix the price of gold under our gold sales contracts
to a date that is earlier than the termination date
of the contract (referred to as the “interim price-setting
date”), the actual realized price on the contract
termination date depends upon the actual gold market
forward premium (“contango”) between the
interim price-setting date and the termination date.
Therefore, the $391/oz price estimate could change
over time due to a number of factors, including, but
not limited to: US dollar interest rates, gold lease rates,
spot gold prices, and extensions of the termination
date. This price, which is an average for the total
Project Gold Sales Contract position, is not necessarily
representative of the prices that may be realized for
actual deliveries into gold sales contracts, in particular,
if we choose to settle any gold sales contract in
advance of the termination date (which we have the
right to do at our discretion). If we choose to accelerate
gold deliveries, this would likely lead to reduced
contango that would otherwise have built up over
time (and therefore a lower realized price).

That mumbo jumbo of an excuse to avoid reporting anything says that if they close out the hedges earlier than 2016, they get less money per ounce of gold!  (Such as $296/oz. as we calculated from their own estimate of the losses, rather than the $391/oz. that they estimate.)

Their "inability to do basic math" is basically their excuse as to why they don't disclose this information in the quarterly reports.

Wow!  Phew!  Barrick can't sue me.  I was right.  They are sneaky deceptive incompetent liars in my opinion, and I can say that, and I can use the way that they burried the information, and their excuse for burrying it, as facts to back up my claim.

My math skills are not as incompetent as they claim their math skills are, since I know how to do a "rough estimate" by using their own numbers, so I will continue to estimate the ramifications of their hedge position as to how it might affect their stock price, and risk of bankruptcy.

So, should we buy Barrick Gold assuming that we anticipate the gold price moving to $2000/oz.?

Let's assume gold price goes up 100% to $2000/oz., and cash costs also increase 100%, as if gold's rising is a purely inflationary phenomenon.

Expected cash costs: $800/oz. at gold price $2000, difference: $1200
x 8 million oz. annual production = $9.6 billion EBITDA gross, about double.
Net income: $2.4 billion, about double.

Expected Price (x 10 for a P/E of 10) = market cap of $24 billion.
Current Price (market cap) = $43.58 Billion 

Therefore, as the gold price rises to $2000/oz., I'd expect the stock price of Barrick to drop from $50 to $27/share, as follows:

$24/$43.58 x $50.16 = $27.62/share.

And what is the hedge loss, at $2000/oz.? 

Hedging of 9.5 million oz. at $296/oz., at a gold price of $2000/oz., difference: $1704/oz. loss.
x 9.5 million oz. = $16.188 billion "mark to market" loss.

I would estimate that Barrick has a mild risk of bankruptcy as gold moves to $2000/oz., since the market cap might drop to $24 billion as their hedging loss rises to $16 billion.  However, since Barrick need not repay these hedges until 2016, and the counterparty is likely the U.S. government, the risk is low.

What happens at $5000/oz., assuming that the gold price manipulation continues through that price, and that cash costs rise proportionally by 5 times?

Cash costs $400/oz. x 5 = $2000/oz.
Gold price $1000/oz. x 5 = $5000/oz.
8 million oz. production x $3000/oz. = $24 billion EBIDTA.

9.5 million oz. hedge position x ($5000/oz. - $296/oz.) = $44.688 billion hedging loss.

The net income was about 1/3 of the EBIDTA.  $24 billion / 3 = $8 billion expected net income.
Expected market cap at $5000/oz. (x 10 for a P/E of 10) = $80 billion.
Expected stock price at $5000/oz. = 80/43 x $50.17 = $93/share.

Therefore, as gold goes from about $1000/oz. to $5000/oz., I'd expect Barrick stock to rise only 86% from $50.17 to $93/share.  In addition, the hedging loss will continue to rise to be about 1/2 of the market cap of the company.

Conclusion: Barrick has no leverage to a rising gold price, not unless the hedges are eliminated, and/or the P/E returns to much lower levels, say around 20 or so, and the stock should be avoided until then.

Gold investors should shun Barrick stock like the plague.

Every time I write "bad things" about some company or other person's business practices, some well meaning so-Called Christian will write to me and say, "Jason, we shouldn't say bad things about others, because it leaves a bad Christian witness" or some other type of nonsense.  Well, I've never seen the scriptures that say we ought to overlook evil and not talk about it.  On the other hand, I have read many verses where we are to expose people when they try to hide things in darkness, and in this article, I just did.

Ephesians 5:11 (NKJV)  "And have no fellowship with the unfruitful works of darkness, but rather expose them."

So, sell 'em, and tell on 'em.

And every time I write about a hedge that is "underwater" or has a mark to market loss, some other well meaning person will ask how it can be counted as a loss, since, technically, the company didn't actually lose that amount, they just won't gain that amount.  Well, I think that's an unreasonable and irrational quibble over words, and I'm using the word "loss" correctly in context and appropriately according to the dictionary.  Every hedge results in either a gain or a loss, or it breaks even, compared to the market price.  In this case, for Barrick, at the present market price it's a loss, and the loss gets bigger as the gold price goes up.

One man asked me, "How can $43 billion worth of capital be wrong?" 

Well, if you are in gold, aren't you saying by your actions that $30 trillion or more worth of bonds is definitely wrong?  Part of the way that $43 billion in capital gets it wrong is because Barrick hides the truth about their hedging loss, by not including it on the latest financial statements.  The fact of the matter is that the vast majority of people don't read the full financial statements, nor do they understand the implications, nor do they run the math to see how it would all work out.

As I wrote yesterday, I owned Barrick stock myself in 1999 for a period of about six months.  But there comes a time when you have to do your own research, and figure out what might be better.  So, I would like to thank the helpful people at for pointing out in 1999 that Barrick had plenty of potentially toxic gold hedges.  Because I listened to them, I saved a lot of money, and made a lot more money in other stocks. 

As it turned out, Barrick stock has not outperformed the gold price since 1999, moving from about $20/share back then to about $50/share today, a gain of $150%.  In contrast, the gold price has moved up far more, from $250/oz. to $950/oz., a gain of $280%.  And gold is poised to continue to gain more than Barrick stock.


    Jason Hommel

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