Bullion banks retreat from gold arbitrage


11p EST Sunday, November 7, 1999

Dear Friend of GATA and Gold:

I think you'll recognize in this article from South
Africa's Business Report a lot of what GATA has been
saying in recent weeks. The bullion banks are the
enemies of both gold and their own clients, the gold
mining companies. But can the gold mining companies
ever stand up to those who control their credit lines?

Please post this as seems useful.

Gold Anti-Trust Action Committee Inc.

* * *


Or, How to Spot the Next Ashanti

By Jonathan Rosenthal
Business Report, Cape Town, South Africa
Friday, November 5, 1999

A prominent London-based gold analyst says he was
having a drink a few weeks ago with a party of bullion
bankers that included one of the counterparties to the
Ashanti hedge book.

Coincidentally, this little gathering took place at
about the time that Ashanti, the Ghanian gold producer
that owns some of Africa's finest mines, was faced with
liquidation because it was unable to come up with the
cash to satisfy its bankers' calls for additional
security on its hedge book.

Ironically, Ashanti's problems were almost entirely the
making of its bankers, who wrapped it up in a hedge
structure that was bound to lose money if the gold
price rose, and who then demanded margin, or security
on the gold loans.

"We really gouged their eyes out," the bullion banker
apparently told his mates, with more than a hint of

When perfectly healthy mines face the prospect of going
belly-up every time the gold price rallies, it becomes
clear that something has gone horribly wrong in the
world of gold hedging and derivatives.

And the lessons of Ashanti have reverberated around the

U.S. investors have now begun firing off letters
threatening to withdraw their investments from hedged
producers like Barrick, and praising the newly
unhedged, like Gold Fields, for their brave stand.

Australian gold producers, known to be hedged to the
hilt, who just a few months ago were darlings of the
market, were made to feel like lepers at the Denver
gold conference last month.

London analysts are now desperately trying to figure
out how hedges work and where the next Ashanti will
come from.

Some have taken to comparing the Ashanti debacle to
that of Bre-X the Canadian junior exploration company
that falsely claimed to have found the world's biggest
gold deposit before its directors disappeared into the
sunset. In the aftermath of Bre-X juniors the world
over battled to find investors to back their projects.

Some analysts now argue that in the post-Ashanti era,
gold companies with even tiny hedges will face a
similar uphill battle to regain the confidence of

But, as with so many matters of market sentiment, the
pendulum has probably swung too far.

When local gold producers first got involved in the
murky waters of gold derivatives in 1982, the idea was
to get a guaranteed floor price for at least a portion
of their production so they could be sure of paying off
loans. In an industry where it can cost several billion
Rand to sink a shaft before producing an ounce of gold,
the idea makes a lot of sense.

The simplest of hedges take the form of forward sales,
which can lock in today's gold price for several years
into the future.

The way it works is that a gold producer asks a bullion
bank to sell gold at today's price. The bullion bank
goes to a central bank and borrows the gold, then sells
it and puts the proceeds into the bank, where they earn

The producer's obligation is then to repay the bullion
bank in gold over a period that usually runs for not
more than five years.

Over that period the producer will produce and give
gold to the bullion bank and get the cash and the
interest earned on it, less the interest payable on the
gold loan itself. The bullion bank then repays the
central bank its gold loan.

Simple enough.

When assessing a company's hedge and its risk of
failure if the gold price rises, one has to look at
whether the producer can actually produce the gold to
repay its gold loans at a total cost below the forward
sale price.

If it can, then it doesn't really matter where the gold
price goes, because it is still producing a profit.

If it can't, then it may have to buy gold at the spot
price to meet its loan obligations. In an environment
of falling gold prices that is just dandy, but if gold
prices rise its opportunity loss becomes a real loss.

The second factor is whether it can be faced with
margin calls. If not, then its bullion bankers have to
be patient and wait for it to deliver gold. But if it
can, then you have the makings of Ashanti II, the
sequel, and the bullion banker saying "we gouged his
eyes out" might just be your own.