Indications said to be bullish for gold


11:30p EST Friday, December 17, 1999

Dear Friend of GATA and Gold:

Here's an updated version of Reginald H. Howe's
essay of yesterday explaining Barrick Gold's hedging
strategy. This version includes a clarification, but I
don't think it changes the substance of Howe's point
at all.

Gold Anti-Trust Action Committee Inc.

* * *

You Bet Your Life:
Barrick vs. Gold Bugs

By Reginald H. Howe
December 17, 1999

The hedge book debate has produced another strange
twist: Barrick Gold disparaging its natural
shareholders, the gold bugs.

Arthur Hailey, the well-known author and former Barrick
shareholder, is trying to instigate a shareholder
revolt against Barrick's gold hedging program. Vince
Borg, Barrick's point man for investor relations,
accuses Hailey and other gold bugs of being irrational
extremists blinded by conspiracy theories about the
gold market. (See P. Kaihla, "Gold bugged," Canadian
Business, Nov. 26, 1999, www.canadian

Barrick, a major gold producer, expects to produce over
3.5 million ounces of gold in 1999 at a total cash cost
of $137/oz. and total cost including depreciation of
$240/oz. It has 51.5 million ounces of proven and
probable reserves and an "A" credit rating. As
currently set forth at its website
Barrick's hedge book includes 14 million ounces (435
metric tons) sold forward under spot deferred contracts
as well as written call options for another 4 million

Barrick's spot deferred program is predicated on the
assumption that "gold has never consistently risen in
price and stayed there." This assumption is
demonstrably false.

Twice in this century the gold price moved quickly to a
new, permanently higher level as a result of
disruptions in the international monetary system. In
1933-34, gold moved in about nine months from
$20.67/oz. to $35/oz., which became the official price
for the next 37 years. Within two years from the
closing of the gold window in 1971, gold moved over
$100/oz., never again to fall significantly below this
level although it would rise much higher. More
generally, the history of all paper currencies is one
of long term depreciation against gold until the paper
eventually expires worthless.

Barrick asserts that it would not be subject to any
margin calls on its hedge book unless gold rises to
over $600/oz. This figure represents slightly more than
a doubling of the gold price from current levels, or a
rate of appreciation between that of 1933-34 (about 70
percent) and 1971-73 (over 150 percent). Spot deferred
contracts at $385/oz., the price Barrick claims to have
locked in through 2001, will not look so smart if gold
moves to $600 quickly and stays there. What is more,
$600/oz. is not far from the price that some claim is
even now about the equilibrium price for gold in a
truly free physical market.

Fundamentally, Barrick's spot deferred contracts are a
bet on continued stability of the dollar and the
exiting international monetary order. There is no
mystery to the falling out between Barrick and the gold
bugs. Fulfillment of the gold bugs' sweetest dreams
represents Barrick's worst nightmare.

(Note: An earlier version of this commentary suggested
that Barrick might be combining its spot deferred
contracts with gold loans. On several rereadings of
Barrick's description of its hedging program, I have
decided that this is probably not the case. Rather, it
seems more likely that Barrick is merely trying to
describe the full mechanics, including the role of the
bullion bank, by which a forward contract yields a

Since this subject engenders considerable confusion (as
well as being one on which I receive numerous e-mails
and questions), I will try to clarify it with an
example. Assume spot gold at $300/oz., one year gold
lease rates at 2 percent, and one year dollar interest
rates at 6%. The one year forward rate -- the
"contango" -- will be about 4 percent. Thus gold for
delivery one year forward will be about $312/oz. A
producer can lock in this price by entering into a
simple or spot deferred forward contract and earn the
contango. (The relationship between lease rates,
interest rates and forward rates is discussed in more
detail in a prior commentary.)

Similarly, on the same assumptions and for the same
reasons, a futures contract on the Comex one year out
will be about $312. Thus a producer could in theory
also sell a futures contract and obtain the same
result. However, as a practical matter, forward
contracts on the over-the-counter market are more
flexible than standardized futures contracts and thus
are generally preferred by producers. For example,
there are no spot deferred contracts on the futures

It is often said, more or less correctly, that a
forward contract involves a spot sale. The basic
mechanics are as follows. When the gold producer enters
into a forward contract to deliver gold, it normally
does so with a bullion bank. The bullion bank typically
borrows the amount of gold that it has agreed to buy
forward from a central bank, sells that gold at spot
(i.e., $300/oz. in my example), and invests the
proceeds in notes of equal maturity with the forward
contract. It pays a lease rate to the central bank and
charges a higher lease rate to the producer on its
forward contract, thus earning the spread on the lease

At the same time, the proceeds from the gold sale are
invested to earn the dollar interest rate. Again, the
bullion bank may earn a small spread, but the essence
of the transaction is that the producer can earn most
of the difference between the dollar interest rate and
the lease rate. In my example, when the time for
delivery arrives, the producer delivers the gold
against payment of $300/oz. plus the contango, and the
bullion bank delivers the gold to the central bank in
payment of its loan. Most importantly, at no time in
this transaction was the bullion bank ever exposed to
fluctuations in the gold price. By selling at spot at
the same time that it was buying for future delivery,
the bullion bank hedged itself against any fluctuations
in the gold price. The principal amount of the
transaction was simply a stated number of ounces of

Forward and spot deferred contracts can contain various
bells and whistles, including provisions allocating the
risk of fluctuations in lease rates, forward rates or
interest rates. Accordingly, these contracts not only
can get quite complicated but also are hard to evaluate
without complete details. Generally, however, by
creating a spot sale and a future purchase, they tend
to depress spot prices. But it is not correct to
suggest, as some do, that forward contracts differ
significantly in this respect from traded futures
contracts. These are typically hedged in substantially
the same way, at least to the extent that a particular
futures merchant may be net short.

Like forward and futures contracts in currencies,
forward and futures contracts in gold are governed by
relative interest rates. To the extent that predictions
about the future enter in, they do so only through
interest rates. But unlike paper currencies, where
there are really no practical constraints on supply,
the supply of gold -- although very large -- is not
unlimited. And unlike most commodity futures, where
delivery of more than a small proportion of total open
interest is not really possible, there is no
theoretical or practical bar to all the longs in gold
futures demanding delivery.

As permanent, natural money, gold is unique. Those who
trade in forward and futures contracts on gold without
understanding its true character do so at considerable
peril, particularly at times of international monetary