Saturday 22 October 2016

All that glitters is not gold when you need to 'hedge'

John Lynch

Published 04/07/2016 | 02:30

The knee-jerk investor response to the Brexit vote in Britain was an entirely predictable rush to gold. It is ever such. Just as soon as trouble appears on the investment horizon punters clamber for the 'yellow metal', whether it is in its physical form like sovereigns or Krugerrands or in the 'paper 'manifestation like exchange-traded funds (ETF) or shares in gold-mining companies.

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I'm all for 'hedges' in turbulent times but was never keen on coins or ingots for two reasons. One was that the security needed to retain them is so expensive and the other was that they yield no dividends. But buying mining shares can also be fraught. Remember Mark Twain's famous line that "a mine is a large hole in the ground with a fool at the bottom and a gangster at the top"?

Post-Brexit, I began to look at Barrick Gold, Canada's mining giant. It has taken only three decades for Barrick to become the world's largest gold producer, thanks to a hectic buying spree conducted by Barrick's chairman, Peter Munk.

Today, the company's major gold mines are in Canada, USA, the Dominican Republic, Argentina and Peru, producing 60pc of the group's output. It also has copper businesses in Chile and Zambia and a significant interest in Acacia Mining plc, formerly Africa Barrick Gold. It is quoted on the Toronto and New York stock exchanges.

When Barrick got a listing in 1983, it was producing 57,000 ounces of gold; last year it was 6.1 million, with North America accounting for almost half. Most observers think Munk was steeped in luck. In 1986, he paid $60m for a Nevada mine with an estimated 600,000 ounces of gold in the ground. In fact, it turned out to have 20 million ounces.

This mine was a mainstay for Barrick, and its profits allowed the company to grow rapidly. However, Munk was also a canny operator and made a practice of selling the company's production at a fixed price to hedge against gold market fluctuations; a clever strategy.

But, as in other areas of life, riding one's luck is never the best thing. Recently, activist shareholders have descended on the company, complaining that new share issues were financing Barrick's acquisitions and outstripped dividends. They pointed out that the company paid almost $300m to board members and executives in the five years up to 2013 and overpaid for some acquisitions. These investors were seeking retrenchment into a smaller player, focusing on mines only in the Americas. The company ignored them.

However, stroppy shareholders have to be mollified. Recently, Barrick told the market that in future it will only invest in high quality, long-life mines and in stable jurisdictions. The company plans to cancel or defer projects not achieving targeted returns. It also stated it has no plans to diversify into other metals or to add to its existing copper operations.

Once the darling of investors for more than two decades, Barrick's share price peaked at $53 in mid-2011, valuing the company at $54bn. The falling price of gold in commodity markets over the last five years has taken its toll on the share price - it dropped to $7 in 2015. Recently, the company attracted attention, with a $260m investment in its share by George Soros pushing the price to above $20. Sales had been holding up and last year reached $10bn, of which gold sales contributed $9bn and copper $1bn.

Concern was voiced as to the company's level of debt, which was not consistent with its prudent reputation. As a result of non-core assets disposals, debt was reduced by $3bn. With world markets being pitched into uncertainty by unprecedented events like Brexit, the irresistible alternative is to go hunting for a 'hedge'. Gold has always been the favourite, if not always the most reliable one. If the gold price rises, so will shares like Barrick.

Irish Independent

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