Barrick Gold’s Hedge Book Has Jumped Up And Bit It On The Chin.
CIBC World Markets have produced a fascinating research note on the last quarterly results from Barrick Gold Corporation, one of the biggest gold producers in the world. The brokers admit that the third quarter earnings of US$0.08 cents/share was slightly ahead of their estimate and those of most other brokers as the concensus had been for earnings of US$0.06 cents/share. It is notoriously difficult to be spot-on with such companies as the results included a US$11 million gain after tax on the sale of some assets and a US$20 million loss, also after tax, on non-hedge derivatives. Operationally the company did well in the three months to end September with production of 1.48 million ozs gold at a cash cost of US$180/oz.
The two analysts, Barry Cooper and Ayesha Hira, were expecting production of 1.4 million ozs at a cash cost of US$190/oz as operations remain weak at two mines – Bulyanhulu and Meikle – while Betze-Post has done rather better. In fact it maintained production at above normal levels as high grade continued. By next year, however, grades at Betze-Post could have dropped by as much as 25 per cent. Meikle’s grades have already fallen and the result was an increase in cash costs to US$291 /oz, but the major problem facing this mine is bad underground conditions due to poor ground. These ground conditions are unlikely to improve, so cash costs may rise further.
Production from Pierina amounted to 215,000 ozs at a cash cost of onlyUS$81/oz. Next year the deposit is expected to see production drop by 400,000 ounces and this trend will start in the next quarter. Since being commissioned in 1998 Pierina has beaten all expectations in terms of output and costs. It was supposed to produce an average of 775,000 ozs at a cash cost of US$60/oz for the first five years. In fact it has actually averaged 846,000 ozs at US$56/oz over this period. Bulyanhulu, meanwhile, continues to struggle and the brokers have increased their estimate for long term costs to about US$190/oz which is well above the level anticipated in the feasibility studies.
Barrick has long prided itself on its expertise in hedging, but the gold hedge book reached a negative US$1.2 billion in the quarter and this compares with the market capitalisation of US$10.4 billion. CIBC World Markets expects the gold price to average US$415/oz next year so the problem is likely to exacerbate.. No ounces were delivered into the hedge book in the third quarter and none are likely in the last quarter as the gold price is well above US$340/oz. In fact the 16 million hedged gold ounces look likely to sit on Barrick’s book for some time to come if CIBC is right about the gold price as the hedge book has a floor of US318/oz. How it will reduce the book is anyone’s guess, but the company has said that it will not use shareholder money to do so.
The analysts make the interesting point that the hedge book can be considered as a 10 year put at US$345/oz with a tenth year call at US$414/oz provided that the counter parties can take no action against Barrick to alter the terms of the agreement. With 16 million ozs due, however, it is likely that the company will have to start delivering into the hedge book at least three to four years before the expiry of the hedges. In a worst case scenario this might mean that the whole of each year’s production might have to be delivered no matter how high the price of gold might have risen in the meantime. The negative mark-to-market value of the book is seen as weighing increasingly heavily on investor sentiment as the years progress.
Despite all this apparent gloom CIBC Markets have set a price target of US$24 per share for Barrick compared with the present price on the New Yorld Stock Exchange of US$19.56. It is categorised as a sector performer which means that the shares are expected to perform in line with the sector during the next 12 to 18 months. The sector itself is expected to outperform the broader market averages over this period which is a comfort as some who have read this research might think the conclusion a bit optimistic.
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