www.globeandmail.com

The Globe and Mail
leaftheglobeandmail

  Betting on a gold bull requires caution

BENJ GALLANDER and BEN STADELMANN

Friday, April 2, 2004

Gold was a standout performer in 2003, but after hitting a high of $428 (U.S.) shortly after the New Year, the expected correction set in. After drifting back to $390, the metal has recovered strongly and gold producers are manoeuvring in anticipation of the next leg of the bull market.

The hookup of Wheaton River and Iamgold was big news. The combination will crack the top 10 list of world producers. We admired Wheaton CEO Ian Telfer's energetic flair in marketing his company and his ability to raise plenty of fresh capital, but questioned whether the incredible growth rate could be profitably managed. Others were evidently far more skeptical: at the time of the announcement, short interest in the stock — a bet that the stock will fall — was more than 16 million shares. This deal puts those folks who bet against Wheaton in the hot seat.

Also high on the industry consolidation agenda is the long-rumoured takeover of Barrick Gold by Newmont Mining. Barrick has been a chronic underperformer during this bull run, while Newmont's head duo of chairman Seymour Schulich and president Pierre Lassonde have proven to be all-star pros. Many thought Newmont would be severely hampered by the ugly hedge book it inherited after its merger with the Australian miner Normandy. Instead, these derivatives were attacked with zeal, the tally reduced from 9.4 million ounces at the end of June 2002 to just 2.55 million ounces recently.

Barrick, on the other hand, is still behind the eight ball in terms of hedging. The recently issued annual report blares in a bold quote: "In 2003 we adopted a no-hedge policy." The change is passed off as a product of the company's improved strength; so robust are the corporation's finances that risk no longer needs to be managed in this fashion. Besides, a helpful pie chart shows that only an 18 percent slice of Barrick's enormous reserves are hedged. Though that may seem relatively innocuous, it is less reassuring if you dig far into the back of the report to assess the dimensions of the derivative hole in absolute terms.

The hedge book of 15.5 million ounces would break even with gold at $304. At $415, the mark-to-market loss was reported at $1.7 billion. And if gold goes to $500? Then this potential loss would be much bigger, a daunting prospect for any suitor. Clearly, Barrick doesn't believe this latter scenario is likely, otherwise it would not have spent $154 million buying back its supposedly undervalued shares when it could have been buying back gold contracts when the price dipped to $321 about a year ago.

Investors in the miners of precious metals should be well aware that, so far, stronger prices have benefited some companies much more than others. As gold moves higher, these disparities are likely to become even more acute. Many players have raised money, diluting their existing share base with the hope of developing properties. Success is highly dependent on the skill of management and the assumptions they have made about their business. If investors don't have confidence in the top brass and are pumped by gold, they are probably better off holding bullion.


back