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Short-term gold lease rates jump again
12:50a EDT Friday, October 8, 1999
Dear Friend of GATA and Gold:
Here's another brilliant essay by Reginald H. Howe,
Harvard-trained lawyer, financial analyst, former
mining company manager, and good friend to GATA,
just posted at his web site, www.goldensextant.com.
It examines the hedging catastrophe at Cambior and
speculates on a way out of it -- a way that closely
resembles GATA's raison d'etre (if we all can parlez
un petit Francais ici.)
That is: Sue the bastards!
Reg surely could put that into French too.
Please post this as seems useful.
CHRIS POWELL, Secretary
Gold Anti-Trust Action Committee Inc.
* * *
THE CAMBIOR CATASTROPHE,
AND MAYBE A WAY OUT OF IT
By Reginald H. Howe
October 7, 1999
The current big worry in the gold mining business is
rock bursts -- not underground but right in the
Hedge books are blowing up. Ashanti and Cambior are the
most visible examples, the share price of each having
been more than cut in half in the past two days due to
major losses in their hedging programs. Cambior's press
release of yesterday holds such unsettling implications
for the gold market that I cannot let it pass without
Cambior is a medium-sized gold producer based in
Montreal. It expects to produce 630,000 ounces of gold
in 1999 at an average cash cost of US$215/oz., and
700,000 ounces in each of the following three years at
an average cost of $200/oz. Over the past 10 years it
has operated a hedging program that it says has
produced an average premium of $57/oz. over the spot
price. While it has experienced some operating problems
in recent years, its management is generally quite
well-regarded in the mining community, and its shares
have heretofore frequently appeared in the reported
holdings of many gold mutual funds.
Its financial report for the second quarter included
the following: quot;As of June 30, 1999, the gold hedging
program had positions ensuring an average price of $350
per ounce for 1.3 million ounces. This program assures
full coverage of the remaining gold production for 1999
at $364 per ounce and 80 percent of the production
exposure for 2000 at $322 per ounce.quot;
Yesterday Cambior reported that as of Sept. 30, 1999,
it had sold forward 2.67 million ounces at an average
price of $318/oz., and had also sold call options for
1.9 million ounces at an average price of $315/oz.
What is even more astonishing is the breakdown of these
Forward sales are: 159,000 ounces at $335/oz. for the
rest of 1999; 642,000 ounces at $298/oz. for 2000;
640,000 ounces at $292/oz. for 2001; and 597,000 ounces
at $292/oz. for 2002, with smaller amounts running out
But the real killer is the call options: 921,000 ounces
at $287/oz. maturing before the end of 1999; 299,000
ounces at $323/oz. in 2000; 382,000 ounces at $352/oz.
in 2001; and 303,000 ounces at $348/oz. in 2002.
Taking the current year, Cambior has already sold
forward the rest of its production (630,000/4 =
157,500) and is now naked on call options some $30 in
the money for an amount of gold almost equal to one and
one-half years of production -- production that itself
has already been sold forward.
You may ask, quot;How the [fill in the blank] could this
There is a hint in the press release: quot;The
counterparties to these hedging contracts consist of
international banks and financial institutions,
principally lenders in the Revolving Credit Facility.quot;
And sure enough, the report for the second quarter
reveals that Cambior has a $250 million five-year
Revolving Credit Facility with the first scheduled
repayment of $54 million due in 2001.
The use of put and call options was discussed in my
commentary of Sept. 11, 1999, quot;Gold Banking and Mining
Finance: Elements of Risk.quot; For mining companies, the
hedge is really the purchase of the put option. In the
declining gold market of recent years, these purchases
were generally financed by writing (selling) call
options, often in a ratio of 2:1, since sale of two
call options would typically finance purchase of one
Particularly in the negative atmosphere following the
Bank of England's announcement of its planned gold
sales, there were many reports of bullion bankers
quot;suggestingquot; to gold mining companies the advisability
of additional puts to protect credit lines. For already
strapped mining companies, purchasing meaningful puts
meant writing calls at strike prices near or below
$300/oz., an obviously risky strategy.
There is another problem with options that those not
familiar with them often overlook: volatility premiums.
The more volatile the market, the higher the premium on
an option. Because markets tend to tank more rapidly
than they rise, puts are often relatively more
expensive than calls.
But in a sharply rising market, particularly one
suggestive of a short squeeze, volatility premiums can
shoot through the roof, which is what is happening now
in gold call options, both over-the-counter and
publicly traded. What is more, the mathematical models
(delta hedging, Black-Scholes, etc.) that are designed
to control risk tend to break down in these
circumstances due to liquidity constraints.
Several points emerge from this picture:
1) Both Cambior and its bankers face a serious
financial problem, and one that will grow a lot worse
should the gold price continue to rise.
2) If Cambior's hedge book is at all representative of
many others, as many well-informed observers suspect,
there is a far larger systemic problem, and one that
will grow exponentially with further increases in the
3) Quite apart from the mining business, if the Cambior
and Ashanti examples are at all representative of
current gold banking practices in general, the over-
the-counter gold derivatives market is almost certainly
in far more parlous condition than all but a very few
4) By extension, all paper gold must now be deemed
In all candor, when I suggested in my last essay that
we might see a gold banking panic in which gold would
go to $1,000 bid, none offered, I knew intellectually
that it could happen but I did not really envisage it
as an imminent possibility.
Cambior's hedge book, c'est incroyable. J'ai peur de ce
qui se passera.
Mais c'est un dommage aussi. Tout le monde sait que
j'aime bien le Quebec et les Quebecois.
It gives me no pleasure at all to write critically of
Cambior, particularly since the problem it faces is not
so much of its own making as it is the work of powerful
people bent on other agendas having nothing to do with
fair play, free markets, hard work, or any other
virtues for which Quebeckers are justly known. Indeed,
it is to Cambior's credit that management faced up to
the problem and put out a detailed, factual press
Free advice is worth what you pay for it. But were I
directing Cambior's affairs, I would have my lawyers
hard at work. In particular, I would ask them if the
Lac Minerals/International Corona case -- a legendary
battle in the annals of Canadian mining -- might have
application here. That case, arising out of the famous
Hemlo discovery, established that a senior mining
company in negotiations with a junior over a
prospective property owes a fiduciary duty to the
junior not to take any undue or improper advantage of
Doesn't this principle suggest that an international
bullion bank dealing with a relatively small gold
mining company owes it a fiduciary duty of full
disclosure of all material facts relating to a proposed
loan transaction and associated hedging?
If so, does it then follow that the bank, if it had any
knowledge thereof, must disclose any facts relating to
the manipulation of the gold market by itself or
My lawyers would probably tell me that the arguments
could be made, but that it would be hard to prove
knowledge of manipulation.
Smiling like the Cheshire cat, I would then suggest
they talk to Bill Murphy at GATA. And forsaking the
finesse of les Habitants for the bad habits of the
Bruins de Boston, I would get ready to take off the