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MANAGING GOLD PRICE RISK AT AMERICAN BARRICK

A CASE STUDY FOR CORPORATE RISK MANAGEMENT


By Group 4 : Budi Setyawan Daniel Indra Mulia Didik Susilo H. Indah Pancawardani Yogi Pamungkas

FM LOGO : Dr. Ida Juda

Agenda

Gold Mining Industry Overview Risk Management at American Barrick Conclusion

Gold Mining Industry

Major Product :
GOLD

Product Usage :
Previously it was used as currency, now

as currency back-up Jewelry (major part, about 80% of current use) Industrial Usage

Production Process (Tech.)

Exploration

Exploration Drilling

Open Pit Mining

Blasting

Underground Mining

Ore and Waste Haulage

Production Process (Tech.)

Heap leaching

Milling

Oxidization

Leaching

Stripping

Electro-winning

Production Process (Tech.)

Smelting

Gold Bullion

Refining

Reclamation

Cost Structure
Major cost comes from the exploration and exploitation /acquisition activities Virtually no marketing and distribution cost (market always ready to absorb their product in market prices) Competitive advantage of a company compared to the others coming from its efficiency in exploration and acquisition cost Highest risk exposure coming from the fluctuation of gold market price

Price Fluctuation Gold spot-price change in the last 30 years *) :

*) www.goldprice.org

Price Fluctuation cont. Gold spot-price last 5 years :

*) www.goldprice.org

Major Industry Players:

Major Gold-mining Firms :


Barrick Gold Corp. Newmont Gold Pegasus Gold LAC Minerals Hostake Mining FMC Gold Echo bay Battle Mtn. Amax Gold

BARRICK Gold Corporation


(also known as American Barrick )

Company Overview
Entered Gold Mining Business in 1983 Largest Gold-mining company in the world (after acquisition of Placer-Dome in 2006), HQ in Toronto, Canada, with 4 Regional Business Unit in Australia, Africa, North America and South America *) Growth from 1984 to 1992: Market capitalization : from $64 M to $5 B Annual production : from 34K Ounces to 1.325M Ounces As of December 2008 : annual production 7.7M Ounces, Proven and probable gold reserves : 138.5M Ounces
*) www.wikipedia.org

Managing Gold Price Risk: The 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 generate new earnings.

Hedge Position

In 90s Barrick hedged more than 90% of its gold production

In 2000s the hedged portion is consistently reduced due to the trend of increasing gold prices

The Hedging Methods

Gold Financing Forward Sales Options Spot Deferred Contracts

Gold Financing
Used to finance the new acquisition (1983-1987) Methods of Gold Financing: Issuing Gold-Trust (It raised $17 millions) The Gold-trust paid the investors 3% of mines output if gold price <= $399 /ounces, rising to 10% if gold price = $1,000 /ounces Bullion Loan : Barrick received gold from the lender-bank which it immediately sold to the market to get cash. Then Barrick repay the loan in monthly installments in ounces of gold with the interest rate of about 2% per year. Issuing Gold-indexed securities

Forward Sales/Contract
The forward sale 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 interest rates for lending Dollar less the gold lease rate. The forward sale eliminates downside risk exposure, but the company lost the opportunity to sell at higher price

Options
Options is the right to choose whether to sell or to buy at a given price

Barrick bought Put Options and sold Call Options to execute a Collar Strategy. This allowed Barrick to benefit from price increases between put option price and call option price . This protected Barrick from price drops without initial cash outlay (it used the premium received from selling the Call Options to buy the Put Options)

$ Payoff

Call

Put Strike price

Spot Deferred Contract


Simple Forward sales or Options are fairly short in duration (1-5 years) which is less than Barricks 20-year production horizon. Barrick began investing in Spot Deferred Contracts (SDCs). SDCs are like forward contracts but have multiple rollover delivery dates over 5-10 year period. Barrick could deliver on specific delivery date or rollover to the next date if it could make more money by selling its gold in the market at the current spot price.

CONCLUSION
The Hedging reduces the risk exposure due to the price drop, at the same time it prevent the company to benefit from price increase The hedging methods, related to the contracted price, time horizon and how many percent the gold production shall be hedged, must be evaluate from time to time in order to get the maximum value for the company

THANK YOU

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