Tuesday, September 15, 2009

Big Troubles Ahead for Barrick Gold (ABX): Company May Not Survive

Antal Fekete is a renowned professor with the San Francisco School of Economics, author of many articles, including "The Last Contango". His writings are somewhat controversial, and usually liked by the gold bugs. Nevertheless, Prof. Fekete is respected in many circles. Perhaps most people are not paying attention. Perhaps it is a similar situation to Prof. Roubini, who before 2008 most dismissed as a permabear cry-wolf type, and we know how his predictions turned out.

Prof. Fekete has now written a new article discussing Barrick Gold's (ABX on the NYSE) recent decision to eliminate its hedges. Prof. Fekete states that Barricks's hedges were never really hedges, they are long-term forward-sales contracts that "the miner has invested and flaunted. He says about the "hedges":

"They are a fraud. They are naked short positions pretending to be balanced by gold ore reserves in the moon (or on this earth which, for hedging purposes, is practically the same thing). "

He goes on to explain that the actual cost or liabilities will be much higher, and will grow,  and that Barrick will not be able to buy the necessary amount of gold:

"The $1.9 billion that Barrick is hoping to raise through this dilution maneuver to eliminate all of its fixed-price gold contracts falls far short of its goal of buying back its hedges. The liability represented by Barrick’s once flaunted forward sale contracts has been carried off balance sheet so far. These fixed-price gold contracts have a negative value of $5.6 billion, that will be charged to earnings in the third quarter. This negative value will almost certainly increase during the next 12-month period Barrick gave itself to get out of the quicksand. The announcement itself is a virtual guarantee of that: Barrick will have to compete in the gold market with China, Russia, India, Brazil, and other countries (not to mention other gold mines in dire need to de-hedge) for a diminishing amount of gold available for cash delivery, to the tune of 9.5 million ounces in today’s strained gold markets."

"The big unknown question is whether Barrick will be able to buy back its hedges fast enough to stop the continuing hemorrhage. Barrick is racing against the clock. Gold is still available for cash delivery, but in what quantities? and for how long? 9.5 million ounces is an awful lot of gold to buy in today’s anemic gold markets with supplies drying up fast."

"...but Barrick’s future is anything but rosy. 9.5 million ounces is a lot more gold than Barrick is able to produce in an entire year in the best of circumstances. Even if Barrick were to sell not one ounce of gold in the open market for a whole year, but deliver every ounce it extracts from the bowels of the earth to its hedge books, and even if we accept the most optimistic assumptions of the company to increase its annual production as realistic, there is still a shortfall of at least 1.5 million ounces. I submit that Barrick could not survive if it was to suspend its sales of new gold in the open market for a whole year, while facing the extra cost of forcing up production quotas. No lender in its right mind would finance such a crazy plan. Creditors of Barrick would be all too happy to put the unfriendly giant on the block, and sell Barrick’s stellar resources to the highest bidders,..."

Mr. Fekete adds that the timing of Barrick's announcement makes him more inclined (but not fully) to believe that Barrick has not been operated as a real mining company at all but as part of a U.S. government scheme to suppress the price of gold.

Strong words.

So the de-hedging annnouncement seemed at first thought, or on the surface, to be  good news for Barrick, specially in light of the recent rising gold market. Never believe the spin!

With Barrick perhaps going all over the place, up or down, here are updated straddles, including for the long term. The maximum moves required are about 24% for 2010 and 45% for 2011. These are very hefty moves, but remember that gold, and specially Barrick,  will be wild in the months ahead.

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