Mdmw-gold14

Gold Mining Industry

Cindy Chen Julia Lee Weiwei Sun Patrick Tan Johanne Lee

Gold Mining Industry Overall Introduction Structure of Industry Financial Structure Risk Assessment Regulatory Environment (FASB)

Overall Introduction Major Product GOLD

Substitutes –Direct Substitutes –Indirect Substitutes •Blooming economic condition

Production Process (Tech.)

Exploration

Exploration Drilling

Open Pit Mining

Blasting

Underground Mining

Ore and Waste Haulage

Production Process (Tech.)

Heap leaching

Leaching

Milling

Stripping

Oxidization

Electro-winning

Production Process (Tech.)

Smelting

Gold Bullion

Reclamation

Refining

Structure of Industry Market Dynamics: – Gold price change

Recent Change in Gold Price Year 2000 – present

Structure of Industry (cont’d) •Major companies (selected by assets) – Barrick Gold Corp. – Newmont Mining – Kinross Gold Corp.

– – – – – – –

Meridian Gold Agnico-Eagle Mines Glamis Gold Goldcorp Inc. Cambior Inc. Ivanhoe Mines Placer Dome

Financial Structure Cost Structure – – – – – –

Exploration, research and development General operation costs Depreciation, depletion and amortization Interest expenses Write-down of assets Other

Financial Structure Revenue Composition – Mining revenue – Interest income revenue – Financial activities revenue (ie. Hedging)

Risk Assessment Nature of Mineral Exploration and Mining Environmental Risks Reserve Estimates Worldwide Operations Licenses and Permits

Risk Assessment (cont’d) Interest Rate Risk Foreign Exchange Rate Risk Commodity Price Risk Derivative Instrument Risk - Credit risk - Market liquidity risk - Mark-to-market risk

Energy Risk

Risk Management Strategies Use of derivatives on commodities – Hedging on Gold

Use of derivatives or other financial

instruments on non-commodity items – Not Hedging on Gold – On fuel, interest rate and foreign exchange rate

FASB 133  Requires companies to recognize all derivatives

instruments as assets or liabilities in the financial statements  Measured at fair market value  Classification of hedges: – – – –

Fair Value Hedge Cash Flow Hedge Currency Hedge Non hedging derivatives

BARRICK Gold Corporation

Corporate Profile Entered Gold Mining Business in 1983 Has operations in the United States, Peru,

Tanzania, Chile, Argentina, Australia and Canada Proven and probable mineral reserves of 86.9 million ounces of gold

Hedging Philosophy  Creates stable, predictable returns regardless of

short-term market conditions.  De-linking Barrick's earnings from the volatility

in the spot gold market.  Creates additional cash reserves that can be used

to acquire new assets to accretive to earnings.

Hedge Position Barrick hedges approximately 18% of its

gold reserves. – 16.1 million ounces or 3 years of expected future production

Between 1991 and 2002, Barrick's forward

sales program allowed the company to generate additional revenue of $2.2 billion

Risk Exposures  Gold and Silver Price Risk  Interest Rate Risk  Foreign Exchange Risk  Derivative Risk • • •

Credit Risk Market Liquidity Risk Mark-to-Market Risk

Hedge Position Current hedge position Financial Statements Tour

Hedging Instruments Spot deferred forward Contracts (90%) Variable price Contracts Options

Spot Deferred Contract  The spot deferred contract is a commitment by the

producer to deliver a fix amount of gold to the contract counterparty at a time in the future at a fixed price.  The forward price of the contract is based on the spot price on the date of the contract plus a premium (contango).  The contango is the difference between the LIBOR less the gold lease rate.  The difference between a spot deferred contract and a simple forward contract is that the spot deferred contract can be rolled over into a new contract on delivery date.

Spot Deferred Contract: Features  The counterparties do not have unilateral and

discretionary ‘right to break’ provisions.  There are no credit downgrade provisions.  Barrick is not subject to any margin calls – regardless of the price of gold.  Barrick has the right to accelerate the delivery of gold at any time during the life of its contracts. This flexibility is demonstrated by the terms that allow Barrick to close out hedge contracts at any time on two days notice.

Spot Deferred Contract: Features Barrick’s trading agreement also specifies that the counter parties can opt for early close out of their contracts in the event of:  a material and lasting impact on Barrick’s ability to deliver gold  the counterparties being unable to borrow gold to facilitate the forward contracts  Barrick having a net worth of less than $2 billion (currently 3.2 billion)  Barrick having a debt to net worth ratio of more than 1.5-2.0:1 (currently 0.25:1)

How It Works Bullion Bank Central Bank Barrick

Barrick enters into the spot deferred contract with the Bullion Bank.

How It Works Bullion Bank Central Bank Barrick

Bullion Bank borrows gold from the Central Bank

How It Works Bullion Bank Central Bank Barrick

Spot Market Sells the gold in the spot market

How It Works Bullion Bank Central Bank

Barrick

1% lease rate Interest earned 4%

How It Works Bullion Bank Barrick

Central Bank

At the delivery date Barrick delivers the gold

How It Works Bullion Bank Barrick

Central Bank

Bullion Bank pays Barrick and returns the gold to the Central Bank

Problems  Barrick faces huge opportunity losses should

gold prices increase  If gold lease rate rises above the Libor rate then forward prices will be in backwardation  If Barrick’s counterparties are not able to borrow gold to facilitate the contract Barrick can be forced to deliver gold at an unfavourable price

Newmont Mining Corporation Creating Value with Every Ounce…

Corporate Profile Incorporated in 1921 Other than gold, also engages in the

production of and exploration for silver, copper and zinc Has operations in North America, Canada, Australia, New Zealand, Indonesia, Uzbekistan and Turkey Owns 86.9 million equity ounces of gold

Creating Value with Every Ounce… Growing reserves Strengthening asset base Increasing earnings per share Paying higher dividends Improving financial strength

Gold Sales Gold sales are made at the average price

prevailing during the month, in which the gold is delivered to the customer, plus a "contango“ Revenue is recognized when the price is determinable upon delivery with title transferred to the customer

Hedging Philosophy A non-hedger Viewing gold as an equivalent to money Creating paper gold is considered too risky

Risk Exposures Commodity Price Risk Foreign Exchange Risk Interest Rate Risk

Commodity Price Risk Metal prices fluctuate – Due to demand, forward selling by producers, central bank sales, purchases and lending, investor sentiment, and global mine production levels

Forward sales contracts with fixed and

floating gold lease rates

Foreign Exchange Risk  Subject to local currency exchange rates against

the US dollars

– A devaluation of local currency is neutral or beneficial, and vice versa

 Currency swap contracts – To hedge the currency risk on repayment of US$denominated debt

 Cross currency swap contracts – To receive A$ and pay US$ – Designated as hedges of A$-denominated

Interest Rate Risk Interest rate swap contracts Against the interest rate risk exposure from

bonds, notes, debentures, and other debts – A reduction in interest expense of $5.9 M in 2002

Hedge Position Currently working to eliminate the hedge

book inherited from the acquisition of Normandy – Hedging 80~95% of total reserves

About 10.3% of Newmont's proven and

probable reserves were subject to derivative contracts

Fair Values of Instruments Gold Commodity Contracts

Ounces (000)

Fair Value (000)

Gold Forward Sales Contracts

3,332

(209,717)

Gold Put Option Contracts

1,544

(22,603)

Gold Convertible Put Options

1,459

(125,486)

Gold Sold Convertible Put Options

240

(14,295)

Price-Capped Contracts

377

n/a

US$/Gold Swap Contracts

600

(87,200)

Fair Values of Instruments Other Sales Contracts, Commodity and Derivative Instruments Cross Currency Swap Contracts Currency Swap Contracts Interest Rate Swap contracts Fixed Rate Debt

Fair Value (000)

(8,500) (21,924) 13,800 1,075

Annual Report 2002

Financial Highlights In 2002: At an average realized gold price of $313 per ounce Sold 7.6 M ounces of gold Revenue of 2,745 million Net cash of 670.3 million

Financial Highlights  Cash Flow Hedges – Accumulated Other Comprehensive Income (Loss) of (54.6M) – Gain (Loss) on Derivative Instruments of (39.8M) Under Financial Statement

 Interest Swaps – Interest, Net of Capitalized Interest is recorded as an expense of 129.6M

 Foreign Currency Exchange Contracts – Dividend, Interest, Foreign Currency Exchange and Other Income of 39.8M

Kinross Gold Corporation “Timing is Everything”

Corporate Profile  Formed in 1993  The 7th largest primary gold producer in the

world  Highly leveraged to changes in the price of gold  A strict non-hedger (approximately 3.5% of reserves hedged falling to zero by early 2005)  Majority of production in North America  Highest beta to bullion responses in a rising gold price environment

Operating Highlights 888,634 gold equivalent ounces Total cash cost US$201 per ounce Net Loss per share US$0.32 Cash flow provided from operating

activities US$0.53 per share

Risk Exposures Commodity Price Risks Foreign Currency Exchange Risk Interest Rate Risk No Speculative or Trading Purposes

Commodity Price Risks Financial instrument in use:  Spot deferred contracts – 312,500 ounce @ $280

 Fixed forward contracts – Unknown

 Written call options – 150,000 ounces @ $326 – Recorded in the financial statements at each measurement date.

Foreign Exchange Risk Financial instrument in use: Foreign exchange forward contracts – Sell U.S. dollars and buy Canadian dollars – CDN $25.8 million at an average exchange rate of 1.5175 – Mature over a 12 month period

Interest Rate Risk Financial instrument in use: Interest rate swaps – There are no interest rate hedging transactions outstanding as at December 31, 2002. – Probably due to lax monetary policy

Energy Price Risk Financial instrument in use: Crude oil forward purchase contracts – As at December 31,2001 – Buy 28,500 barrels of crude oil forward at a price of $20.83 per barrel. – No hedging agreements in place

Fair Values of Instruments In 2002: $20.3 million recorded as loss on forward contract $0.8 million recorded as loss on foreign currency contracts

Financial loss Loss incurred from Interest and other

income – $65.6 million

Share in loss of investee companies – $12.9 million Mark-to-market loss on call options – $2.7 million (pg 88)

Comparison Risk Management Philosophy Barrick

Newmont Kinross

De-linking Barrick's earnings from the volatility in the spot gold market. non-hedging philosophy non-hedging philosophy

Recommendation: Barrick To maintain its current hedge book In-line with its hedging philosophy Not cave in to shareholder pressure

Recommendation: Newmont To keep reducing its hedge book to zero In-line with its non-hedging philosophy Not creating paper gold and thus

fluctuating gold prices

Recommendation: Kinross To remain as a non-hedging firm Since Kinross is small in size, relative to

others, one way to attract investor is to offer higher beta to bullion price

Empirical Studies on Hedging in Gold Mining Industry Investors value volatility when it comes to

gold mining stocks The more a firm hedges gold price risk the worse it is for their stock return Gold mining firms that aggressively hedge gold price are not maximizing shareholder value ~~Matthew Callahan, “To hedge or not to hedge…from the North American gold mining industry”

Conclusion Overall, a decreasing trend on hedging

position is observed

Any Questions?