American Barrick Resources Corporation
Managing Gold Price Risk
1. Jewelry (80%) 1. Expanding Production
2. Commercial and Soviet Union
Industrial use South Africa
3. Back-up for currencies North America
2. Central Banks
Factors that may increase gold price:
1. Large government deficits
2. Financial and economic crisis
3. Wars and doomsday scenarios
4. Increase in gold jewelry demand ?
5. Commercial and Industrial demand ?
Factors that may decrease gold price:
1. Financial and economic stability
2. Trends towards democracy and free markets
3. Effective use of monetary policy by central banks
4. Liquidation by central banks
Should Gold Producers Hedge Gold Price Risk?
1. Protect ...view middle of the document...
Normal forward contract
FT = S (1 + i)T
Gold forward contract
FT = S (1 + i - g)T = S (1 + c)T
where c = i - g
c = contango rate
i = dollar interest rate
g = gold lease rate
The main disadvantages
1. Sacrifices the upside
2. Quantity produced must be known
1984-85 experience – hedged at the wrong time
3. Put Options and Warrants
The main advantages
1. Does not sacrifice the upside
2. Quantity produced doesn’t have to be known exactly
The collar Strategy
Buy puts (with a low exercise price) financed by writing calls (with a high exercise price).
Example – Buy a put at $420 per ounce
Write a call at 550 per ounce
Or, Buy a put at $420 per ounce
Write 0.5 calls at 485 per ounce
See exhibit 11
The main disadvantages
1. Option contracts of maturities longer than 5 years unavailable
2. Market was illiquid for maturities longer than 2 years.
4. Spot Deferred Contracts
1. Like a forward contract but allows delivery at the chosen dates by the seller of the forward contract.
2. The forward prices are given as:
FT = S (1 + c1)(1+c2)(1+c3)…(1+cT)
Where S is today’s Comex gold price and
ct (t = 1, 2,…T) is the contango rate between time t – 1 and t, prevailing at time t - 1.
3. If an SDC forward contract is written on 5 million ounces of gold over five years, then the seller can decide how much is to be delivered when but the entire 5 million ounces should be sold over five years at the appropriate forward prices.
4. Allows a minimum price (protects from downside risk), and yet the advantage of temporary price upswings. Can smooth earnings flow.
The main disadvantage:
If the gold price rises steadily forever, then the delivery can only be postponed, but will have to be made at some point in the future. However, the long-term trend in gold price seems downward, so this may not be such a disadvantage