American Barrick Resources

American Barrick Resources differs from most metals and mining companies in that it seeks to hedge out its commodity price exposure to gold, thereby reducing financial risks that result from sudden drops in gold prices, but also reduces upside opportunities. Absent hedging, Barrick's P&L would fluctuate with the gold sport price. Revenues move quickly with spot prices while cost related to mining and refining tend to be more stable.

How would the fluctuations affect the value of the company? One could think of the value of the company as the present value of future cash flows. For simplicity we can assume that all costs are incorporated in the cash cost, thus a 1% increase in spot price would be equal to a $4,417,104 (1% x $345/oz x 1,280,320 oz (delivered in 1992)) increase in cash flows based on the information presented in Exhibit 12. Capitalized at a 10% discount rate in perpetuity this would create a $44 million swing in value of the company, which represents a 4.4% change on net assets (based on Exhibit 2). Without hedges, Barrick would be leveraged to gold price: a change of 1% would influence the value of the company by more than 1 percent.

Barrick employs derivatives in its hedging strategy. To counter its long exposure to physical gold, it utilized forwards to sell gold forward short (i.e., lock in the current market price) and uses other derivatives such as Spot-Deferred Contracts (SDCs). SDCs are essentially a series of forward contracts, with one important difference. Rather than settling the contract at a specified interval, Barrick has an option to defer deliveries. In such a case, the gain or loss on the initial contract would be incorporated in the following roll-over contract. Thus, if Barrick did not like the price at the settlement date, it could roll the dice one more time, until the next settlement date and so on. An SDC is essentially a forward contract that does not need to be immediately settled - it can be rolled forward and marked-to-market for settlement at a later date, which may help Barrick manage its hedging cash flows more easily.

If Barrick did not have access to gold derivatives, a potential way to manage gold price exposure on the revenue side would be by using forward sales with customers (i.e., enter into long-term delivery contracts that specify the quantity and the price of gold to be delivered in the future) or ramping production up or down depending on the gold price regime. Barrick could also manage gold price exposure on the cost side by getting creative with its supply contracts - similarly to the bullion loans that had interest denominated in ounces, Barrick could attempt to negotiate payment for its capital equipment that was indexed to the gold price, or settle payments directly in gold.

It is surprising that more gold mining firms do not hedge gold price risk, given the capital requirements of these businesses.