2GOLD MINING INDUSTRYDemand & supply of goldProduction of goldMarket dynamicsLarge producersFirm cost structure and revenue compositionFirm strategies going forward
3DEMAND & SUPPLY OF GOLDThe market dynamics of gold are dominated by short-term supply and demand fluctuationsSudden surge in demand or disruption in supply can lead backwardation, where the spot price is higher than the forward priceThe gold market is usually in contango, due to the smoothing of supply that is possible due to accessible stocks.
7How Gold is MinedSmeltingGold BullionRefiningReclamation
8HOW GOLD IS TRADEDOver the CounterBetween principals, not through exchangesContracts terms are flexibleMain centers: London, New York, and ZurichMining companies and central banks tend to transact their business through London and New YorkTwice daily during London trading hours there is a “fix” which offers reference prices for that day’s trading.
9THE SETTLEMENT PROCESS The basis of settlement is delivery of a standard London Good Delivery Bar, at the London vault nominated by the dealer who made the sale. Currency settlement for gold transactions will generally be in US dollars over a US dollar account held in New York.
11Gold Prices Comparisons Like all prices, the gold price reflects not only the inherent value of gold, but also the relative strength of the currency in which it is quoted.
12LARGEST GOLD PRODUCERS BY MARKET CAPITALIZATION Companies:Anglo American PLCNewmont Mining Corp.Barrick Gold Corp.AngloGold Ashanti Ltd.Placer Dome Inc.Gold Fields Ltd.Market Capitalization:35.87B20.28B13.73B10.10B7.76B6.26B
13FIRM COST STRUCTURE & REVENUE COMPOSITION Costs applicable to sales of gold and other base metalsDepreciate, depletion & amortizationDepreciation, depletion, & amortizationExploration, research & developmentGeneral & administrativeMergers and resturingWrit-down of long lived assetsOthersRevenue CompositionSales of goldSale of other base metalsGain on investmentGain on derivative instrumentGain on dividends, interest & foreign exchange income
14ISSUES FACING GOLD COMPANIES There have been only a few large deposits found since 1998 and none of these have made it to production as of yetRising costs with gold prices impose questions of the ability to finance and develop projectsCopper-gold projects will become more common in gold company portfolios
15FIRM STRATEGIES & KEY SUCCESS FACTORS Effective cost control to maximize margin by improving supply chain management and usage of technologies such ase-commerceStrategic balance between gold mine grades produced and life of assetsContinuous commitment to research & development to uncover large gold deposits
16RISK ASSESSMENTThree major market risks faced by firms in gold mining industries:Commodity Price RiskForeign Exchange Rate RiskInterest Rate Risk
17COMMODITY PRICE RISKCommodity Price Risk = Gold Price Risk (the change in the price of the gold)It affects gold mining companies’Asset valuesProfitability of its operationsCash flows generated those operations
18COMMODITY PRICE RISKThe price of gold is affected by numerous factors:Demand for gold in both jewellery and industrial usesInternational/regional, political/economic trendsThe relative strength of U.S dollars of other currenciesFinancial market expectationsNumbers of speculative activitiesReservesNumber of forward salesProduction and cost levels for gold
19FOREIGN EXCHANGE RISKIs the change in the relative values of currenciesSince gold mining companies do not have the luxury of choosing where the ore bodies are, they usually have their mining operations, activities, investment outside of their countriesTheir revenue and costs are primarily incurred in foreign currenciesAdverse movement will affect a company’s:Cash flowsProfitability
20INTEREST RATE RISKInterest rate exposures impact a company’s:Cash BalancesBorrowings (to meet short falls in current cash flows)Long term debtsHedging activities (the impact international interest rate differentials)Returns on its assetsFirm valueSignificant decrease in interest rates and/or increase in gold lease rates can have a great negative impact on the price of the new gold sales contract and on the difference between the forward gold price & current spot price
21EFFECTIVE RISK MANAGEMENT All gold mining companies face a similar exposureThe prospects depend on its risk management decisions and strategiesFirm characteristics play a major role in risk management
22MEASUREMENT OF RISKSMethods vary across industries and firms within the same industryNo specific requirements needed for gold mining companiesIn theory, should use delta calculationDelta: the change in the value of a portfolio with respect to a change in the price of the underlying asset (gold)Delta % : portfolio delta / amount of gold produced over 3 years
23MEASUREMENT OF RISKSBUT:Most gold mining companies do not use this delta calculationNo mention of the volatility of spot gold pricesInstead, they only briefly mention that a certain dollars per ounce change in the gold price would result in an increase or decrease in approximately how many dollars change in cash flow from operations and net income.
24TECHNIQUES AND PRODUCTS Gold producers can use:Future ContactsGold loanGold SwapsSpot deferred contractForward sales of goldPut options (Insurance purpose)To hedge themselves against the exposures
25DERIVATIVE USAGE FOR GOLD PRICE RISK Most gold mining companies use:Forward contractsSpot deferred contractPut and call optionGold lease rate swapsMost prefer to use forward contracts as its hedging instruments due to the introduction of SFAS NO 133/138This allows gold producers to not consider their sales contracts as derivative instruments as long as they are considered to be normal salesGold mining firms can record the proceeds under this contract as revenue and can be held off balance sheet until maturity, the date of the delivery of the gold in the future
26DERIVATIVE USAGE FOR FOREIGN CURRENCY RISK Gold mining companies use:Currency forwardsCurrency optionsSince gold is quoted and traded in US dollars, gold producers with operations and investment in a large number of countries outside U.S will be exposed to foreign exchange rate risks
27DERIVATIVE USAGE FOR INTEREST RATE RISK Gold mining companies ONLY use:Medium to long term horizon interest rate swapInterest rate risk is not viewed as important as the gold price risk and currency risk due to the low leverage in the gold mining industry
28FIRM CHARACTERISTICS FACTORS Firm SizeIs measured by the firm’s gold reserves representing the maximum collateral value and the market value of assetsIt is proven that firm size is negatively correlated with the degree of hedgingSmaller firms tend to have little negotiation power and have a higher chance of facing higher financing costsLiquidityIs important in determining how much funds a firm can provide in terms of emergenciesWith a large cash balance, firms will face fewer financial constraints and hardshipsSo, they do less hedging as their risk management strategies
29FIRM CHARACTERISTICS FACTORS LeverageFirms with higher leverage have a higher chance of facing financial constraintsThey do more hedging in their risk management strategiesSince gold mining industry has low leverage levels, it will not have a major impact on the firmsAverage Cash CostIs important element in determining gold mining companies’ profitability, efficiency and productivityThere is a positive association between financial distress and average cash costSince smaller firms tend to have a higher cash cost average than large firms, they have a greater tendency to encounter financial distress when the price of gold decreases
30POTENTIAL HAZARDSGold mining companies use different derivative instruments to hedge themselves against the risks that they face from potential future movement in market variablesThe main motives for hedging:To cover the total operating costsRemove price riskEnhance revenueControl their cash flows
31POTENTIAL HAZARDBUTNo assurance that outcome of hedging will be better than the outcome without hedgingLeave firm’s profit to be dependent solely on the underlying productive activitiesMay suffer opportunity loss
32RISKS DUE TO HEDGINGBy hedging, firms face:Credit riskMarket liquidity riskMark to market riskRisks associated with factors such as:Default by counterpartyCosts associated with unwinding the positionPossible restrictions on credit linesIn order to develop an effective risk management program, a firm should make a clear statement about the firm’s risk management philosophy