More on Barrick's
Hedges
We recently critiqued a report on Barrick's
hedge programme written by Dr Martin Murenbeeld. Dr Murenbeeld defended
Barrick's practice of forward selling a large quantity of gold primarily
on the basis that the practice had worked well over the past 15 years.
Our view, however, was that the major trend changed in October of 2000
and it didn't make sense to assume that what worked during the old (strong
Dollar / weak gold) trend will work during the new (strong gold / weak
Dollar) trend. We also stated that Barrick would probably not be able to
roll-forward its hedges in a very strong gold market because central banks
would either stop lending their gold or would only lend it at a much higher
interest rate.
Dr Murenbeeld's response to our criticisms
can be read HERE.
While he accepts our point that the merits of Barrick's hedge program must
be assessed over a complete cycle, he disagrees that Barrick will have
a problem rolling forward its hedges. In response to our assertion that,
in a very strong gold market, gold will either not be available for borrowing
or will only be available at a much higher interest rate, Dr Murenbeeld
writes:
"Several central bankers have told
me that as long as there is demand for gold liquidity they will provide
it. They make money doing so, and they retain ownership of the gold!
Indeed, I think the issue of central bank willingness to lend gold is a
non-issue."
And...
"...things that go up have low interest
rates, things that go down have high interest rates. This is the "layman's"
variant of the famous Fisher Theorem, and is well established in the currency
world: weak currencies have high interest rates and strong currencies have
low interest rates. Applied to the gold market, gold lease rates are lower
than dollar rates when gold is expected to rise relative to the Dollar.
Central banks will find only few borrowers in a 'steamy' gold bull market;
ergo, gold bullion rates will be very low indeed."
We won't bother addressing the first
of the above statements except to point out that anyone who invests/trades
based on what central bankers say they are going to do, is doomed to lose
money.
The second statement is more important
because it clearly shows why Dr Murenbeeld is probably going to be proven
wrong. In fact, the statement is wrong on two levels.
Firstly, the Fisher Theorem often applies,
but it is not difficult to find exceptions. For example, the Yen has been
trending lower against the US$ since mid-1995, yet US$ interest rates have
been higher than Yen interest rates over this entire 7-year period. Another
example is provided by the euro-US$ exchange rate over the past 15 months.
During this period the US$ fell by about 20% against the euro while short-term
US$ interest rates remained below short-term euro interest rates. A third
example is provided by the euro-US$ exchange rate during the 1999-2000
period. During this period euro interest rates remained well below US$
interest rates even though the euro was by far the weaker currency.
In each of the three examples cited
above, the stronger currency had the higher interest rate. So, blindly
assuming that the Fisher Theorem is going to 'hold up' makes little sense,
particularly if you are putting your money at risk.
Secondly and more importantly, just
because interest rates are low doesn't mean that low interest rates will
be available to all borrowers. For example, in the US over the past 12
months extremely low interest rates have been available to borrowers in
the Commercial Paper (CP) market, but many companies that were once able
to borrow in the CP market have now been 'shut out'. Very few companies
now have access to these low rates because lenders have become far more
risk averse. The US bond market, where we currently have 10-year US Government
Treasury Notes yielding less than 4%, provides another example. Only the
US Government can borrow at this low rate. There are many companies that
wouldn't be able to sell their debt even if they offered rates of 10%-15%.
Currently, the central banks are pricing
zero risk of default into the interest rates they charge the borrowers
of their gold. At the same time, the financial markets and the ratings
agencies have begun to factor a greater risk of default into the debt issued
by some of the largest counter-parties (the bullion banks that act as intermediaries)
in the gold-hedging business. Is it reasonable to expect that the central
banks will continue to ignore the risk of counter-party default? We don't
think so.
In summary, the 'natural gold interest
rate' will not necessarily be the main determinant of the interest rate
that any particular borrower pays. In fact, we think there is a good chance
that central bankers will soon start to become more risk averse when it
comes to their nations' gold reserves, especially considering the financial
problems currently being faced by some of the largest counter-parties in
the gold-lending business.
By the way, Barrick Gold has recently
announced its intention to substantially reduce the size of its hedge book.
This is good news for Barrick shareholders, but we would continue to avoid
this stock because there are much better opportunities elsewhere.
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and
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