American Barrick Resources Corporation - Managing Gold Price Risk

CASE: American Barrick Resources Corporation : Managing Gold Price Risk

1. In the absence of a hedging program using financial instruments, how sensitive would Barrick stock be to gold price changes? For every 1% change in gold prices, how might its stock be affected? How could the firm manage its gold price exposure without the use of financial contracts?

Particulars for yr 1992($ million)

Pretax earnings (Exhibit 2) 223

Reductions in earning of gold sold at spot (1280mn oz x (422-345) (Exhibit 12) (99)

Proforma Pretax Earnings 124

Taxes @ 21% (Exhibit 2) (26)

After Tax Earnings 98

Thus in absence of risk management program the American Barrick stock would be more sensitive to gold price changes. This could also be observed from Exhibit 4 where the return on Barrick's stock is continuously increasing as compared to other unstable major stocks in gold mining sector.

Elasticity of Earnings & Profit for 1% change in Gold Price

1% change in gold price ($345) $3.45

Number of ounces $1,280m

Additional pre-tax profits $4.4m

Additional after-tax profits $4.4 x (1-.21) = $3.5mn

Additional profits as % of earnings 3.5/98 = 3.5% (approx)

Cash Flow = Earnings + Noncash charges 98mn + 69mn = $167mn

Additional profits as % of cash flow 3.5/167 = 2.1%

Thus with 1% change in gold price the earnings of Barrick would change by 3.5%.

The firm can manage its gold price exposure in following three ways:

1. Diversifying its business

2. Hedging against the gold price risk

3. Insuring against the gold price risk

Hedging involves entering into financial contracts and so does insuring against the gold price risk. Thus without being involved in any financial contracts Barrick can reduce its gold price exposure only by diversifying its business.

2. What is the stated intent of ABX's hedging program? What should be the goal of a gold mine's price risk management program?

Stated intent

American Barrick Resources Corporation is one the most financially successful gold-mining concerns in the world. The main stated intent of ABX's hedging