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
–Indirect Substitutes
•Blooming economic
condition
 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
 Structure of Industry
Market Dynamics:
– Gold price change
Recent Change in Gold Price
Year 2000 – present
Structure of Industry (cont’d)

•Major companies (selected by assets)

– Barrick Gold Corp. – Meridian Gold

– Newmont Mining
– Kinross Gold Corp.
– Agnico-Eagle Mines
– Glamis Gold
– Goldcorp Inc.
– Cambior Inc.
– Ivanhoe Mines
– Placer Dome
Financial Structure

Cost Structure
– Exploration, research and development
– General operation costs
– Depreciation, depletion and amortization
– Interest expenses
– Write-down of assets
– Other
Financial Structure

Revenue Composition
– Mining revenue
– Interest income revenue
– Financial activities revenue (ie. Hedging)
Risk Assessment

Nature of Mineral Exploration and Mining

Environmental Risks
Reserve Estimates
Worldwide Operations
Licenses and Permits
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

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

 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
BARRICK Gold Corporation
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

 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

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

 Gold and Silver Price Risk

 Interest Rate Risk
 Foreign Exchange Risk
 Derivative Risk
• Credit Risk
• Market Liquidity Risk
• Mark-to-Market Risk
 Hedge Position

Current hedge position

Financial Statements Tour
Hedging Instruments

Spot deferred forward Contracts (90%)

Variable price Contracts
Options
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
 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:
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

Bullion Bank
Central Bank
Barrick

Barrick enters into the spot deferred contract with the Bullion
Bank.
 How It Works

Bullion Bank
Central Bank
Barrick

Bullion Bank borrows gold from the Central Bank

 How It Works

Bullion Bank
Central Bank
Barrick

Spot Market

Sells the gold in the spot market

 How It Works

Bullion Bank
Central Bank
Barrick

1% lease rate

Interest earned 4%
 How It Works

Bullion Bank
Central Bank
Barrick

At the delivery date Barrick delivers the gold

 How It Works

Bullion Bank
Central Bank
Barrick

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

Creating Value with Every Ounce…

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…

Growing reserves
Strengthening asset base
Increasing earnings per share
Paying higher dividends
Improving financial strength
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 Philosophy

A non-hedger
Viewing gold as an equivalent to money
Creating paper gold is considered too risky
Risk Exposures

Commodity Price Risk

Foreign Exchange Risk
Interest Rate 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

 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 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 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
Fair Values of Instruments

Gold Commodity Ounces Fair Value

Contracts (000) (000)
Gold Forward Sales Contracts 3,332 (209,717)
Gold Put Option Contracts 1,544 (22,603)
Gold Convertible Put Options 1,459 (125,486)
Gold Sold Convertible
240 (14,295)
Put Options
Price-Capped Contracts 377 n/a
US$/Gold Swap Contracts 600 (87,200)
Fair Values of Instruments

Other Sales Contracts,

Commodity and Derivative Fair Value (000)
Instruments

Cross Currency Swap Contracts (8,500)

Currency Swap Contracts (21,924)

Interest Rate Swap contracts 13,800

Fixed Rate Debt 1,075

Annual Report 2002
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 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

“Timing is Everything”
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

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 Exposures

Commodity Price Risks

Foreign Currency Exchange Risk
Interest Rate Risk
No Speculative or Trading Purposes
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 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 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

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 Instruments

In 2002:
$20.3 million recorded as loss on forward
contract
$0.8 million recorded as loss on foreign
currency contracts
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

Risk Management Philosophy

Barrick De-linking Barrick's

earnings from the volatility
in the spot gold market.
Newmont non-hedging
philosophy
Kinross non-hedging
philosophy
Recommendation: Barrick

To maintain its current hedge book

In-line with its hedging philosophy
Not cave in to shareholder pressure
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

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

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

Overall, a decreasing trend on hedging

position is observed
Any Questions?