gold mining industry cindy chen julia lee weiwei sun patrick tan johanne lee

Gold Mining Industry

Cindy ChenJulia Lee

Weiwei SunPatrick Tan

Johanne Lee

Gold Mining Industry

Overall IntroductionStructure of IndustryFinancial StructureRisk AssessmentRegulatory Environment (FASB)

Overall Introduction

Major ProductGOLD

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

Reclamation

Refining

Structure of Industry

Market Dynamics:– Gold price change

Recent Change in Gold Price

Year 2000 – present

Structure of Industry (cont’d)

– Barrick Gold Corp.

– Newmont Mining

– Kinross Gold Corp.

– Meridian Gold– Agnico-Eagle Mines – Glamis Gold – Goldcorp Inc. – Cambior Inc. – Ivanhoe Mines– Placer Dome

•Major companies (selected by assets)

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 MiningEnvironmental RisksReserve EstimatesWorldwide OperationsLicenses and Permits

Risk Assessment (cont’d)

Interest Rate RiskForeign Exchange Rate RiskCommodity Price RiskDerivative 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 valueClassification of hedges:

– Fair Value Hedge– Cash Flow Hedge– Currency Hedge– Non hedging derivatives

BARRICK Gold Corporation

Corporate Profile

Entered Gold Mining Business in 1983Has 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

a) Credit Risk

b) Market Liquidity Risk

c) Mark-to-Market Risk

Hedge Position

Current hedge position

Financial Statements Tour

Hedging Instruments

Spot deferred forward Contracts (90%)Variable price ContractsOptions

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.

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)

Spot Deferred Contract: Features

How It Works

Barrick

Bullion Bank

Central Bank

Barrick enters into the spot deferred contract with the Bullion Bank.

Barrick

Bullion Bank

Central Bank

Bullion Bank borrows gold from the Central Bank

How It Works

How It Works

Barrick

Bullion Bank

Central Bank

Spot Market

Sells the gold in the spot market

BarrickCentral Bank

Interest earned 4%

Bullion Bank

1% lease rate

How It Works

BarrickCentral Bank

Bullion Bank

At the delivery date Barrick delivers the gold

How It Works

Barrick

Central Bank

Bullion Bank

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

How It Works

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 1921Other 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 reservesStrengthening asset baseIncreasing earnings per sharePaying higher dividendsImproving 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-hedgerViewing gold as an equivalent to moneyCreating paper gold is considered too risky

Risk Exposures

Commodity Price RiskForeign Exchange RiskInterest 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 versaCurrency 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 CommodityContracts

Ounces (000)

Fair Value (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 Put Options

240 (14,295)

Price-Capped Contracts 377 n/a

US$/Gold Swap Contracts 600 (87,200)

Fair Values of Instruments

Other Sales Contracts, Commodity and Derivative Instruments

Fair Value (000)

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 ounceSold 7.6 M ounces of goldRevenue of 2,745 millionNet 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 1993The 7th largest primary gold producer in the

worldHighly leveraged to changes in the price of goldA strict non-hedger (approximately 3.5% of

reserves hedged falling to zero by early 2005)Majority of production in North AmericaHighest beta to bullion responses in a rising gold

price environment

Operating Highlights

888,634 gold equivalent ouncesTotal cash cost US$201 per ounceNet Loss per share US$0.32Cash flow provided from operating

activities US$0.53 per share

Risk Exposures

Commodity Price RisksForeign Currency Exchange Risk Interest Rate RiskNo Speculative or Trading Purposes

Commodity Price Risks

Financial instrument in use:Spot deferred contracts

– 312,500 ounce @ $280Fixed forward contracts

– UnknownWritten 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 bookIn-line with its hedging philosophy Not cave in to shareholder pressure

Recommendation: Newmont

To keep reducing its hedge book to zeroIn-line with its non-hedging philosophyNot creating paper gold and thus

fluctuating gold prices

Recommendation: Kinross

To remain as a non-hedging firmSince 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 IndustryInvestors value volatility when it comes to

gold mining stocksThe more a firm hedges gold price risk the

worse it is for their stock returnGold 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?