The Barrick Gold Conundrum

A lot of speculation surrounds the recent announcement by Barrick Gold to raise $3.5 billion in equity to finance buy-backs of its gold hedges. While some lesser banks have taken this development as an immediate opportunity to upgrade the stock (not all that difficult into a rising market, even if common gets diluted by 94.8 million new shares), others have speculated that this is nowhere near enough to remove the full overhang of the existing hedges. A more relevant question is, why now, and what does this portend for the gold (and not just) market.

Rob Kirby, in an interview with Max Keiser, shares his perspective on the situation (a must watch not only because Kirby touches on several other key topics, including the JPM interest-rate swap domination, a topic Zero Hedge has discussed previously in detail, and where we are eagerly awaiting the latest and greatest OCC report, due at the end of September, in order to see just how big the Mutual Assured Destruction bomb that Ben Bernanke and Jamie Dimon will soon be threatening the US population with, but also just to revel in Max' expository passion).

 

A good and comprehensive overview of the Barrick situation, presented by less than biased and axed to the teeth sellside analyst teams-cum-prop desks, comes courtesy of Adam Graf at Dahlman Rose. In a note released to clients on September 10, Adam writes [highlights ours]:

Reducing Forward Gold Hedges. On September 8th, Barrick announced a $3.0 billion equity issuance to finance a gold hedge buy-back. On September 9th, Barrick announced it had expanded its equity issuance to $3.5 billion by issuing 94.8 million common shares at a preliminary deal price of $36.95 per share. Common shares outstanding have increased from approximately 873 million shares to approximately 968 million shares (982 million shares if the over allotment option is exercised in full).


Market-to-Market. Based on a $993/oz spot gold price, Barrick will record a $5.6 billion liability on its balance sheet. A $5.6 billion charge to earnings will be recorded in the third quarter as a result of a change in accounting treatment for the contracts. Barrick intends to use $1.9 billion of the net proceeds to eliminate all of its 3 million ounce fixed priced gold contracts (sold forward at $370/oz) within the next 12 months and approximately $1.5 billion to eliminate a portion of its 6.5 million ounce floating spot price gold contracts.


Hedges Remain. Based on our calculations, Barrick has estimated a cost of $569 per ounce to close the floating rate contracts. At that price, and based on the $3.5 billion equity raise, they should be able to close out approximately 2.6 million ounces of floating rate contracts. That should leave about 3.86 million floating contracts after all the cash from the announced equity raise is depleted. On this basis, to completely close out Barrick’s hedge book would require an additional $2.2 billion. The company has indicated that they could use debt to close out the remaining hedges if the cost of that debt was less than 5%.

Zero Hedge will not touch upon the apocryphal observations seen in other blogs discussing violent moves in gold any time Barrick does a readjustment of its hedge positions. Nonetheless, the massive (relatively speaking) move up in gold is not an isolated phenomenon, and has certainly got not just the gold fans following every tick, but also has some bullion bank executives likely very, very nervous. Throw in some aggressive ongoing gold repatriation, and all of a sudden this generally quiet corner of the commodities world could soon start looking very, very interesting.