Transcript The Gold Industry - SFU Home Page - SFU

The Gold Industry
Presented by:
Andreana Lu Yang
Ivy Wai Ting Fung
Simon Wisniewski
Jeff d’Avignon
1
Gold Mining Industry
 Demand & supply of gold
 Production of gold
 Market dynamics
 Large producers
 Firm cost structure and revenue
composition
 Firm strategies going forward
2
Demand & Supply
of Gold
 The market dynamics of gold are dominated by
short-term supply and demand fluctuations
 Sudden surge in demand or disruption in supply
can lead backwardation, where the spot price is
higher than the forward price
 The gold market is usually in contango, due to the
smoothing of supply that is possible due to
accessible stocks.
3
Demand & Supply
of Gold
4
How Gold is Mined
Exploration
Blasting
Exploration Drilling
Underground Mining
Blasthole Drilling
5
Ore & Waste Haulage
How Gold is Mined
Heap Leaching
Mining
Oxidization
6
Leaching
Stripping
Electro-winning
How Gold is Mined
Smelting
Gold Bullion
Refining
7
Reclamation
How Gold is Traded
 Over the Counter
 Between principals, not through exchanges
 Contracts terms are flexible
 Main centers: London, New York, and Zurich
 Mining companies and central banks tend to
transact their business through London and
New York
 Twice daily during London trading hours
there is a “fix” which offers reference prices
for that day’s trading.
8
The Settlement Process
 The basis of settlement is delivery of a
standard London Good Delivery Bar, at
the London vault nominated by the
dealer who made the sale. Currency
settlement for gold transactions will
generally be in US dollars over a US
dollar account held in New York.
9
Market Dynamics: Gold
Prices
10
Gold Prices Comparisons
 Like all prices, the gold price reflects not only the inherent
value of gold, but also the relative strength of the currency
in which it is quoted.
11
Largest gold producers
by market capitalization
Companies:
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Anglo American PLC
Newmont Mining Corp.
Barrick Gold Corp.
AngloGold Ashanti Ltd.
Placer Dome Inc.
Gold Fields Ltd.
Market Capitalization:






35.87B
20.28B
13.73B
10.10B
7.76B
6.26B
12
Firm Cost Structure &
Revenue composition
 Cost Structure:
 Costs applicable to sales of
gold and other base metals
 Depreciate, depletion &
amortization
 Depreciation, depletion, &
amortization
 Exploration, research &
development
 General & administrative
 Mergers and resturing
 Writ-down of long lived
assets
 Others
 Revenue Composition





Sales of gold
Sale of other base metals
Gain on investment
Gain on derivative instrument
Gain on dividends, interest &
foreign exchange income
13
Issues Facing Gold
Companies
 There have been only a few large deposits
found since 1998 and none of these have
made it to production as of yet
 Rising costs with gold prices impose
questions of the ability to finance and
develop projects
 Copper-gold projects will become more
common in gold company portfolios
14
Firm Strategies &
Key Success Factors
 Effective cost control to maximize margin by
improving supply chain management and
usage of technologies such as
e-commerce
 Strategic balance between gold mine grades
produced and life of assets
 Continuous commitment to research &
development to uncover large gold deposits
15
Risk Assessment
 Three major market risks faced by firms in gold
mining industries:
 Commodity Price Risk
 Foreign Exchange Rate Risk
 Interest Rate Risk
16
Commodity Price Risk
 Commodity Price Risk = Gold Price Risk
(the change in the price of the gold)
 It affects gold mining companies’
 Asset values
 Profitability of its operations
 Cash flows generated those operations
17
Commodity Price Risk
 The price of gold is affected by numerous
factors:
 Demand for gold in both jewellery and industrial
uses
 International/regional, political/economic trends
 The relative strength of U.S dollars of other
currencies
 Financial market expectations
 Numbers of speculative activities
 Reserves
 Number of forward sales
 Production and cost levels for gold
18
Foreign Exchange Risk
 Is the change in the relative values of currencies
 Since gold mining companies do not have the
luxury of choosing where the ore bodies are,
they usually have their mining operations,
activities, investment outside of their countries
 Their revenue and costs are primarily incurred
in foreign currencies
 Adverse movement will affect a company’s:
 Cash flows
 Profitability
19
Interest Rate Risk
 Interest rate exposures impact a company’s:




Cash Balances
Borrowings (to meet short falls in current cash flows)
Long term debts
Hedging activities (the impact international interest
rate differentials)
 Returns on its assets
 Firm value
 Significant decrease in interest rates and/or
increase in gold lease rates can have a great
negative impact on the price of the new gold
sales contract and on the difference between the
forward gold price & current spot price
20
Effective Risk Management
All gold mining companies face a
similar exposure
The prospects depend on its risk
management decisions and
strategies
Firm characteristics play a major role
in risk management
21
Measurement of Risks
 Methods vary across industries and firms
within the same industry
 No specific requirements needed for gold
mining companies
 In theory, should use delta calculation
 Delta: the change in the value of a portfolio
with respect to a change in the price of the
underlying asset (gold)
 Delta % : portfolio delta / amount of gold
produced over 3 years
22
Measurement of Risks
 BUT:
 Most gold mining companies do not use this
delta calculation
 No mention of the volatility of spot gold prices
 Instead, they only briefly mention that a certain
dollars per ounce change in the gold price
would result in an increase or decrease in
approximately how many dollars change in cash
flow from operations and net income.
23
Techniques and Products
 Gold producers can use:


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
Future Contacts
Gold loan
Gold Swaps
Spot deferred contract
Forward sales of gold
Put options (Insurance purpose)
ǂ
To hedge themselves against the exposures
24
Derivative Usage for
Gold Price Risk
 Most gold mining companies use:
 Forward contracts
 Spot deferred contract
 Put and call option
 Gold lease rate swaps
 Most prefer to use forward contracts as its hedging
instruments due to the introduction of SFAS NO 133/138
 This allows gold producers to not consider their sales
contracts as derivative instruments as long as they are
considered to be normal sales
 Gold mining firms can record the proceeds under this contract
as revenue and can be held off balance sheet until maturity,
the date of the delivery of the gold in the future
25
Derivative Usage for
Foreign Currency Risk
 Gold mining companies use:
 Currency forwards
 Currency options
 Since gold is quoted and traded in US dollars,
gold producers with operations and investment
in a large number of countries outside U.S will
be exposed to foreign exchange rate risks
26
Derivative Usage for
Interest Rate Risk
Gold mining companies ONLY use:
 Medium to long term horizon interest rate
swap
Interest rate risk is not viewed as
important as the gold price risk and
currency risk due to the low leverage in
the gold mining industry
27
Firm Characteristics Factors
 Firm Size
 Is measured by the firm’s gold reserves representing the
maximum collateral value and the market value of assets
 It is proven that firm size is negatively correlated with the
degree of hedging
 Smaller firms tend to have little negotiation power and
have a higher chance of facing higher financing costs
 Liquidity
 Is important in determining how much funds a firm can
provide in terms of emergencies
 With a large cash balance, firms will face fewer financial
constraints and hardships
 So, they do less hedging as their risk management28
strategies
Firm Characteristics Factors
 Leverage
 Firms with higher leverage have a higher chance of facing
financial constraints
 They do more hedging in their risk management strategies
 Since gold mining industry has low leverage levels, it will not
have a major impact on the firms
 Average Cash Cost
 Is important element in determining gold mining companies’
profitability, efficiency and productivity
 There is a positive association between financial distress
and average cash cost
 Since smaller firms tend to have a higher cash cost average
than large firms, they have a greater tendency to encounter
financial distress when the price of gold decreases
29
Potential Hazards
 Gold mining companies use different derivative
instruments to hedge themselves against the
risks that they face from potential future
movement in market variables
 The main motives for hedging:
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To cover the total operating costs
Remove price risk
Enhance revenue
Control their cash flows
30
Potential Hazard
BUT
 No assurance that outcome of hedging
will be better than the outcome without
hedging
 Leave firm’s profit to be dependent solely
on the underlying productive activities
 May suffer opportunity loss
31
Risks due to Hedging
 By hedging, firms face:
 Credit risk
 Market liquidity risk
 Mark to market risk
 Risks associated with factors such as:
 Default by counterparty
 Costs associated with unwinding the position
 Possible restrictions on credit lines
 In order to develop an effective risk
management program, a firm should make a
clear statement about the firm’s risk
management philosophy
32
Newmont Mining
Corporation
Creating Value with Every Ounce …
33
Corporate Profile
 Incorporated in 1921
 Trades on NYSE, Australian and Toronto stock
exchanges (NYSE & ASX: NEM; TSX: NMC)
 Newmont Mining Corporation is the world’s largest gold
producer
 Has operations in US, Canada, Australia, Peru,
Indonesia, Uzbekistan, Turkey, Bolivia, New Zealand and
Mexico
 The only S&P 500 gold stock
 In addition to gold, also engages in the production and
exploration of silver, copper and zinc
 Most of Newmont’s revenues come from the sale of
refined gold in the international market
34
Newmont Properties
35
Creating Value with Every Ounce…
 ACHIEVED STRONG EARNINGS GROWTH AND CASH FLOW
GENERATION
 Net income of $476 million, $1.16 earnings per share
 $589 million net cash provided from operations, after using $121
million for the settlement of effective cash flow hedges
 DEMONSTRATED OPERATING EXCELLENCE ACROSS ALL
CORE REGIONS
 Gold sales of 7.4 million equity ounces
DEMONSTRATED LEVERAGE TO THE GOLD PRICE
 Unhedged philosophy
 Substantially eliminated the acquired Australian gold hedge
books
 Record gold reserves of 91.3 million equity ounces
STRENGTHENED BALANCE SHEET
36
 Reduced debt by $739 million
Financials
Today: Can$ 53.730
52-Week High 61.950
EPS 1.36
P/E 39.50
52-Week Low 48.110
37
Hedging Philosophy
 With respect to gold, Newmont’s philosophy is to remain
largely unhedged and the corporation generally sells its
gold production at market prices
 Historically, Newmont has, on a limited basis, entered
into derivative contracts to protect the selling price for
certain anticipated gold productions and to manage risks
associated with:
 Commodity price changes
 Foreign currency changes
 Interest rates changes
 The hedging policy authorized by Newmont’s Board of
Directors limits total gold hedging activity to 16 million
ounces
38
Commodity Price Risk
 Newmont’s business is extremely dependent on the
price of gold, which is affected by numerous factors
beyond Newmont’s control:
 Actions by governments and central banks, a strong U.S. dollar,
recessions, speculative trading, decreased demand, high supply
of gold from production, disinvestment, scrap and hedging sales
by gold producers in forward transactions and other hedging
transactions
 Any drop in the price of gold adversely impacts
Newmont’s revenues, profits and cash flows, particularly
in light of their unhedged philosophy
 Based on estimates of Newmont’s stand-alone 2004
production and expenses, a $10-per-ounce change in
the gold price would result in an increase or decrease of
approximately $55 million in cash flow from operations
and approximately $50 million in net income
39
Elimination of Hedge Positions
 Following the Normandy (now Newmont Australia)
acquisition, and in accordance with the company’s
unhedged philosophy, efforts to reduce and simplify the
Normandy hedge positions have been undertaken
 Accordingly, the Normandy gold hedge books have been
reduced by approx. 9.4 million ounces since February
2002
 Gold forward sales contracts and other “committed
hedging obligations” were reduced by 7,547,000 ounces
since February 15, 2002 by delivering production into the
contracts or through early close outs
 Thus, as of December 31, 2003, the gold hedge book
has been eliminated
40
Use of Derivatives
 Newmont had no gold forward sales contracts at December 31,
2003, although positions existed at December 31, 2002.
 Newmont had $11,758 million fair value of gold put option contracts
outstanding at December 31, 2003 and $22,604 million back on
December 31, 2002.
 Newmont had no gold convertible put option contracts and other
instruments outstanding at December 31, 2003, although positions
existed at December 31, 2002.
 Newmont had no gold sold convertible put option contracts
outstanding at December 31, 2003, although a position did exist at
December 31, 2002.
41
Price-Capped Sales Contracts
 In September 2001, Newmont entered into transactions that closed
out certain call options through replacement with a series of forward
sales contracts requiring physical delivery of the same quantity of
gold over slightly extended future periods
 Under the terms of the contracts, Newmont will realize the lower of
the spot price on the delivery date or the capped price ranging from
$350 per ounce in 2005 to $392 per ounce in 2011.
 These forward sales contracts are accounted for as normal sales
contracts under SFAS 133.
42
USD/Gold Swap Contracts
 Prior to Newmont’s acquisition, Normandy entered into a
USD/gold swap contract whereby principal payments on
USD bonds were swapped into gold-denominated
payments of 600,000 ounces in 2008
 This instrument was marked to market at each period end,
with the change reflected in income until the contract was
closed out during the NYOL buy back transaction
 This position was extinguished as part of the NYOL
voluntary administration process and the fair value of this
instrument at December 31, 2002 was a negative $87.2
million
43
Fair Values of Instruments
2002
Gold Commodity Contracts
Ounces
(000)
2003
Fair
Value
(000)
Fair
Value
(000)
Gold Forward Sales
Contracts
3,332
-209,718
0
Gold Put Option Contracts
1,544
-22,604
-11,758
Gold Convertible Put Options
1,459
-125,486
0
240
-14,295
0
2,350
n/a
n/a
600
-87,200
0
Gold Sold Convertible Put
Options
Price-Capped Contracts
USD/Gold Swap Contracts
44
Foreign Exchange Risk
 Currency fluctuations may affect the costs that Newmont
incurs at its operations
 Gold is sold throughout the world based principally on the U.S.
dollar price, but a portion of Newmont’s operating expenses are
incurred in local currencies
 The appreciation of non-U.S. dollar currencies against the U.S.
dollar can increase the costs of gold production in U.S. dollar
terms at mines located outside the United States, making such
mines less profitable
 The currencies that primarily impact Newmont’s results of
operations are the Australian and Canadian dollars
 During 2003, both currencies strengthened by an average of 17%
and 11%, respectively, against the U.S. dollar. This increased U.S.
dollar reported operating costs in Australia and Canada by
approximately $76.2 million and $7.6 million
45
Foreign Currency
 Newmont acquired certain cross currency swap
contracts in the Normandy transaction intended to hedge
the currency risk on repayment of US dollardenominated debt
 These contracts were closed out during the quarter
ended June 30, 2002 for net proceeds of $50.8 million.
The contracts were accounted for on a mark-to-market
basis until closed out, resulting in a loss to income of
$8.5 million for the period from February 15, 2002
through December 31, 2002
 Newmont also acquired currency swap contracts to
receive AUD and pay USD designated as hedges of
AUD denominated debt. The contracts are accounted for
on a mark-to-market basis with the change recorded in
earnings
46
Foreign Currency
 To the extent that there are fluctuations in local
currency exchange rates against the U.S. dollar,
the devaluation of a local currency is generally
economically neutral or beneficial to most
operations since local salaries and supply
contracts will decrease against the U.S. dollar
based revenue stream
 The year ended December 31, 2003 included a
foreign currency translation gain of $97.0 million
amongst other things composed a $27.4 million
mark-to-market gain on ineffective foreign
currency swaps
47
Interest Rate Swaps
 During the last half of 2001, Newmont entered into
contracts to hedge the interest rate risk exposure on
a portion of its $275 million 8.625% debentures and
its $200 million 8.375% debentures
 The fair value of the derivative assets was $5.3
million at December 31, 2003 and the fair value of
the hedge portion was $7.7 million and $16.9 million
at December 31, 2003 and 2002, respectively
 The Company has managed some of its fixed rate
debt exposure by entering into interest rate swaps
48
Fair Values of Instruments
2002
2003
Fair Value
(000)
Fair Value
(000)
Cross Currency Swap Contracts
-8,500
0
Currency Swap Contracts
-21,924
7,669
Interest Rate Swap contracts
16,900
7,700
Fixed Rate Debt
1,075
639
Other Sales Contracts,
Commodity and Derivative
Instruments
49
Employee Stock Options
 The Company maintains stock option plans for
executives and eligible employees
 Options to purchase shares of stock can be granted
with exercise prices equal to or greater than the
market value of the underlying stock at the date of
grant
 The options vest over periods ranging from two to
four years and are exercisable over periods of up to
ten years
 At December 31, 2003, 11,767,961 shares were
available for future grants under the Company’s
employee stock plans
50
Employee Stock Options
 Certain key executives were granted options that,
although the exercise price was equal to the fair
market value on the date of grant, cannot be
exercised unless the market price of Newmont’s
common stock is a defined amount above the
option exercise price
 In addition, the same executives were granted
options with exercise prices in excess of the fair
market value on the date of grant
 These key executive options vest over a period of one to
five years and are exercisable over a ten-year period
 At December 31, 2003, 89,863 of these options were
outstanding and 44,931 were exercisable
51
52
Corporate Profile
 Founded in 1983 when three small mining and
oil and gas companies were merged as Barrick
Resources Corp.
 Barrick Gold Corporation engages in the
production and sale of gold, including related
mining activities such as exploration, development,
mining and processing.
 Shares are traded under the ticker symbol ABX
on the Toronto, New York, London and Swiss stock
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exchanges and the Paris Bourse.
Corporate Profile
Barrick Gold Corporation is among the world’s
largest gold producers of market capitalization, gold
production and reserves.
North America's #2 gold producer behind Newmont
Mining.
 Barrick's hedging practices, which have become its
distinguishing feature, came under attack from
investors in 2000, despite company estimates that it
earned an additional $391 million through hedging
in
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1999 and another $300million in 2000.
Operations
 Operates a low-cost portfolio of 12 mines and four major
development projects on four continents :
North America, South America, Africa and Australia
 The Company’s development plan is expected to add four
major new mines between 2005 and 2008. Together, these
mines are projected to produce approximately 2 million plus
ounces of gold annually
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
Operations
In 2004 the Company’s 12 operating mines produced about 5 million ounces
of gold (5.51 in 2003), at a cash cost of $212 per ounce ($189 in 2003), the
lowest cash cost of all senior producers.
 For 2005, the Company expects gold production to be 5.4 to 5.5 million
ounces at an average total cash cost of $220 to $230 per ounce.
 The Company increased its reserves by over 3 million ounces during 2004,
with gold mineral reserves of 89 million ounces as at December 31.
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Financials
•Public Company (NYSE: ABX; Toronto: ABX)
•Fiscal Year-End December
2004 Sales (mil.)
1,932.0
1-Year Sales Growth`
-5.1%
2004 Net Income (mil.)
248.0
1-Year Net Income Growth
24.0%
2003 Employees
7,100
1-Year Employee Growth
4.4%
The industry's only A-rated balance sheet with no net debt.
Rank #468 in FT Global 500 and included in the TSX 6057
Financials
Income Statement
Balance Sheet
Cash Flows Statement
58
Financials : Performance
Today: US$ 25.600
52-Week High 26.320
EPS 0.46
P/E 55.70
52-Week Low 18.040 Indicated
59
Risk Exposures
Gold Price Risk
Interest Rate Risk
Foreign Exchange Risk
Derivative Risk
•Credit Risk
•Market Liquidity Risk
•Mark-to-Market Risk
60
Risk Management Philosophy
• Barrick is known as
one of the more successful hedgers in the
industry (the company estimates its hedging strategy has added
more than $2 billion since the late 1980s)
• In 2003, Barrick implemented a no-hedge strategy the wake of
rising gold prices - a significant departure from previous practice.
• Financial risk management has given the Company the ability to
grow reserves and production, allowing it to significantly increase
its leverage to the gold price. Barrick has more than four out of
every five ounces of reserves currently unhedged.
61
Risk Management Philosophy
• Barrick use derivative instruments
to mitigate the effects of certain risks that are inherent in its business, and also
to take advantage of opportunities to secure attractive pricing for commodities, currencies and interest rates.
• The inherent risks that Barrick most often attempts to mitigate by the use of derivative instruments occur from
changes in commodity prices (gold and silver), interest rates and foreign currency exchange rates. Because Barrick
produces gold and silver, incurs costs in foreign currencies, and invests and borrow in US dollars and is therefore
subject to US interest rates, its derivative instruments cover natural underlying asset or liability positions.
• The purpose of the hedging elements of Barrick’s derivative program is so that changes in the values of cash
flows from hedged items are offset by equivalent changes in the values of derivative instruments. Barrick does not
hold derivatives for the purpose of speculation; its risk management programs are designed to enable Barrick to
plan its business effectively and, where possible, mitigate adverse effects of future movements in gold and silver
prices, interest rates and foreign currency exchange rates.
62
Hedging Activities
The main types of derivatives Barrick uses are:
• Forward gold and silver sales contracts.
• Interest rate swaps.
• Foreign currency contracts.
• Gold lease rate swap contracts.
63
Hedging Activities
• Barrick mainly use over-the-counter (“OTC”) derivative contracts. Using
privately negotiated master trading agreements with its counterparties,
Barrick is, in many cases, able to secure more favorable terms than if it
used exchange-traded derivative instruments. Barrick has been able to
negotiate these master trading agreements due to its credit standing and the
quality and long-life nature of its mines and gold mineral reserves.
64
Hedging Activities
•Barrick values derivative instruments using
pricing inputs that are readily available from
independent sources. The fair value of the
contracts is mainly affected by, among other
things, changes in commodity prices,
interest rates, gold lease rates and foreign
currency exchange rates.
65
Hedging Activities
Barrick use of these contracts is based on
established practices and parameters, which
are subject to the oversight of the Finance
Committee of the Board of Directors.
Barrick also maintain a separate compliance
function to independently monitor its hedging
and financial risk management activities and
segregate the duties of personnel responsible
for entering into transactions from those
responsible for recording transactions. 66
Hedging Activities
Forward gold and silver sales contracts:
These contracts provide for the sale of future gold production in fixed
quantities with delivery dates at our discretion over a period of up to
15 years.
67
Hedging Activities
Interest rate swaps:
These instruments are used to counteract
the volatility of variable short-term interest
rates by substituting fixed interest rates over
longer terms on cash and short-term
investments. Barrick also use interest rate
swaps to swap our interest due on long-term
debt obligations from fixed to floating, to take
advantage of the present low interest-rate
environment.
68
Hedging Activities
Foreign currency contracts:
These instruments are used for the cash
flows at Barrick’s operating mines and
development projects from forecasted
expenditures denominated in Canadian and
Australian dollars to insulate them from
currency fluctuations.
69
Hedging Activities
Gold lease rate swap contracts:
These contracts are used to manage the
fixed gold lease rate element of fixedprice forward gold sales contracts and to
take advantage of lower short-term gold
lease rates.
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The End
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