The workout phase of the gold-carry trade has arrived

Section:

Barrick Gold's Buyout of Homestake
Stokes Conspiracy Theorists

By Aaron L. Task
Senior Writer
www.TheStreet.com
June 25, 2001

SAN FRANCISCO -- Things aren't always what they seem on
Wall Street, particularly in the gold market. That
truism was glaringly evident today in the reaction to
news Homestake Mining agreed to an $8.71 per share
buyout offer from Barrick Gold.

At first glance, the deal was greeted as one might
expect. Homestake's shares -- the third most active in
Big Board trading -- gained 21% as Barrick's offer
represented a 31% premium over Friday's close. Barrick
shares slid 4.6%, reflecting that Barrick will issue
about 140 million of its shares to pay for the deal and
assume $225 million of Homestake's long-term debt.
Barrick said the acquisition will dilute its 2001
earnings but add to its results in 2002.

One spin on the news -- and my initial one -- was that
the deal is bullish for gold stocks because Barrick's
management is considered among the savviest in the
industry. The purchase could be viewed as an indication
that Barrick believes shares of smaller gold miners, if
not the metal itself, are undervalued. The Philadelphia
Stock Exchange Gold and Silver Index rose 0.2% today
while major averages slumped, save the Nasdaq
Composite.

Furthermore, with the Federal Reserve set to lower
interest rates this week for the sixth time this year,
recently dampened inflation fears may resurface, giving
gold and related shares a boost. That'll be especially
true if the central bank eases by 50 basis points.

"Now is the time for gold to start glittering,"
suggested Paul Kasriel, chief U.S. economist at
Northern Trust Co. of Chicago, in a report out Friday.

Kasriel, one of the foremost advocates of inflation's
re-emergence, noted fed funds are currently about 40
basis points above the 3.62% year-over-year change in
the Consumer Price Index, the tightest spread since
1993.

"Gold starts to come into its own as a desired asset
class when you can no longer get an honest return on
your money," which occurs when fed funds falls below
inflation, he argued. "My guess is that some investors
are starting to nibble at gold because of expectations
that the funds rate will drop below the consumer
inflation rate in the not-too-distant future."

Today, the price of gold rose 0.5% to $274.70.
Meanwhile, fed funds futures are pricing in 54% odds
for a half-point rate cut.

But as suggested above, many gold market participants
weren't enthralled by the Homestake-Barrick deal.

"It's an unmitigated disaster," said one trader of
mining stocks. "I see no reason to do this transaction.
[Homestake] could have achieved a 30% premium in the
blink of an eye if the gold market hiccups."

A big reason for frustration over the deal is that
Barrick is an aggressive hedger while Homestake is not.
Hedging refers to mining companies selling future
production at a fixed cost, in order to protect
themselves against potentially lower prices.

Assuming completion of the merger, the combined
Barrick-Homestake will have about 18 million ounces, or
about 20% of its reserves, hedged at a minimum price of
$345 an ounce.

Although that's well above spot market prices, hedging
is anathema to gold bugs, who believe the practice
contributes to a vast effort by central banks and
broker/dealers to artificially suppress the price of
gold. Some of the more aggressive conspiracy theorists
accused Homestake CEO Jack Thompson, who will become
vice chairman of the combined entity, of essentially
selling out to the enemy.

While that's a fringe view, the first question on the
conference call was about hedging, specifically whether
Barrick would increase its activities to account for
the newly acquired Homestake production.

Not at all, Barrick CEO Randall Oliphant replied on the
call, noting the company has traditionally hedged
between 20% and 25% of its reserves. "Given the
positive tone in the gold market, we're comfortable
where we are today, and have no plans to change" the
hedged book, he said.

Meanwhile, Thompson indirectly addressed the "sellout"
charge on the conference call. Agreeing to the offer
was "bittersweet," he said, but Barrick's financial
muscle gives it flexibility to pursue growth either
through internal development or via acquisition. He
lamented that Homestake didn't have that luxury as a
standalone entity. Additionally, Barrick is one of the
lowest-cost gold producers and rates high on most other
industry measures of financial health.

"I'm a fairly large shareholder of Homestake, and if
you look at our future and the options available, in
our estimation our prospects are much better as part of
this [combined] company," Thompson said. "We're
creating an exciting vehicle for people to invest
[in]." Jack in a Box

But Thompson's enthusiasm was not shared by some other
Homestake shareholders. "What's upsetting some people
is that Homestake has hedged very little while Barrick
is one of the worst offenders," said Jean-Marie
Eveillard, manager of the $10 million First Eagle SoGen
Gold fund. "I don't want to move from a nonhedger to
the worst offender." Eveillard also expressed concern
that Barrick will increase its hedging activities going
forward. Oliphant's comments notwithstanding, that was
one reason gold prices initially dipped on news of the
deal, traders said.

Finally, the 30% premium is "theoretical" because it's
based on Barrick's stock price and not a cash offer, he
said.

The fund manager said he will either sell his existing
Homestake position or sell the Barrick shares once the
exchange is accomplished. If others follow a similar
strategy, "then incidentally it should be positive for
other mining companies that don't hedge" much,
including Newmont Mining, Gold Fields of South Africa,
and Franco Nevada, he said. Newmont and Gold Fields,
however, both ended lower on the session while Franco
Nevada gained just 0.3% in Toronto Stock Exchange
trading.

The First Eagle Gold fund, which was up 22.9% year to
date through Friday, has long positions in all three
(as well as Homestake).

Eveillard also manages the $1.7 billion First Eagle
SoGen Global fund, which is up 7.9% year to date and
has an approximate 4% position in gold stocks.

"We've always looked at [gold] as an insurance policy
and after a 20-year [gold] bear market, it's a cheap
insurance policy," he said. "If something goes wrong to
the point where financial assets get into real trouble,
the upside in gold and more so gold stocks is
tremendous and can offset substantial losses incurred
in financial assets."

Gold and related stocks may very well be good insurance
in these uncertain times. But today's action shows
again that the sector is far from boring or
predictable.