GOLD
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GOLD MINING INDUSTRY
Demand & supply of gold
Production of gold
Market dynamics
Large producers
Firm cost structure and revenue composition
Firm strategies going forward
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DEMAND & SUPPLY
OF GOLD
The market dynamics of gold are dominated by shortterm supply and demand fluctuations
Sudden surge in demand or disruption in supply can
lead backwardation, where the spot price is higher than
the forward price
The gold market is usually in contango, due to the
smoothing of supply that is possible due to accessible
stocks.
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Demand & Supply
of Gold
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How Gold is Mined
Exploration
Blasting
Exploration Drilling
Underground Mining
Blasthole Drilling
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Ore & Waste Haulage
How Gold is Mined
Heap Leaching
Mining
Oxidization
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Leaching
Stripping
Electro-winning
How Gold is Mined
Smelting
Gold Bullion
Refining
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Reclamation
HOW GOLD IS TRADED
Over the Counter
 Between principals, not through exchanges
 Contracts terms are flexible
 Main centers: London, New York, and Zurich
 Mining companies and central banks tend to
transact their business through London and New
York
 Twice daily during London trading hours there is a
“fix” which offers reference prices for that day’s
trading.
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THE SETTLEMENT PROCESS
The basis of settlement is delivery of a standard
London Good Delivery Bar, at the London vault
nominated by the dealer who made the sale.
Currency settlement for gold transactions will
generally be in US dollars over a US dollar account
held in New York.
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Market Dynamics: Gold
Prices
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Gold Prices Comparisons
 Like all prices, the gold price reflects not only the inherent
value of gold, but also the relative strength of the currency
in which it is quoted.
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LARGEST GOLD PRODUCERS BY MARKET
CAPITALIZATION
Companies:
Market Capitalization:
 Anglo American PLC
 35.87B
 Newmont Mining Corp.
 20.28B
 Barrick Gold Corp.
 13.73B
 AngloGold Ashanti Ltd.
 10.10B
 Placer Dome Inc.
 7.76B
 Gold Fields Ltd.
 6.26B
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FIRM COST STRUCTURE &
REVENUE COMPOSITION
 Cost Structure:
 Costs applicable to sales of gold and other
base metals
 Depreciate, depletion & amortization
 Depreciation, depletion, & amortization
 Exploration, research & development
 General & administrative
 Mergers and resturing
 Writ-down of long lived assets
 Others
 Revenue Composition
 Sales of gold
 Sale of other base metals
 Gain on investment
 Gain on derivative
instrument
 Gain on dividends,
interest & foreign
exchange income
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ISSUES FACING GOLD COMPANIES
There have been only a few large deposits found since
1998 and none of these have made it to production as of
yet
Rising costs with gold prices impose questions of the
ability to finance and develop projects
Copper-gold projects will become more common in gold
company portfolios
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FIRM STRATEGIES &
KEY SUCCESS FACTORS
Effective cost control to maximize margin by improving
supply chain management and usage of technologies such
as
e-commerce
Strategic balance between gold mine grades produced
and life of assets
Continuous commitment to research & development to
uncover large gold deposits
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RISK ASSESSMENT
Three major market risks faced by firms in gold mining
industries:
 Commodity Price Risk
 Foreign Exchange Rate Risk
 Interest Rate Risk
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COMMODITY PRICE RISK
Commodity Price Risk = Gold Price Risk (the change
in the price of the gold)
It affects gold mining companies’
 Asset values
 Profitability of its operations
 Cash flows generated those operations
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COMMODITY PRICE RISK
The price of gold is affected by numerous factors:
 Demand for gold in both jewellery and industrial uses
 International/regional, political/economic trends
 The relative strength of U.S dollars of other currencies
 Financial market expectations
 Numbers of speculative activities
 Reserves
 Number of forward sales
 Production and cost levels for gold
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FOREIGN EXCHANGE RISK
Is the change in the relative values of currencies
Since gold mining companies do not have the luxury of
choosing where the ore bodies are, they usually have their
mining operations, activities, investment outside of their
countries
Their revenue and costs are primarily incurred in foreign
currencies
Adverse movement will affect a company’s:
 Cash flows
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 Profitability
INTEREST RATE RISK
Interest rate exposures impact a company’s:
 Cash Balances
 Borrowings (to meet short falls in current cash flows)
 Long term debts
 Hedging activities (the impact international interest rate
differentials)
 Returns on its assets
 Firm value
Significant decrease in interest rates and/or increase in gold
lease rates can have a great negative impact on the price of the
new gold sales contract and on the difference between the
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forward gold price & current spot price
EFFECTIVE RISK MANAGEMENT
All gold mining companies face a similar exposure
The prospects depend on its risk management
decisions and strategies
Firm characteristics play a major role in risk
management
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MEASUREMENT OF RISKS
Methods vary across industries and firms within the
same industry
No specific requirements needed for gold mining
companies
In theory, should use delta calculation
Delta: the change in the value of a portfolio with respect
to a change in the price of the underlying asset (gold)
Delta % : portfolio delta / amount of gold produced
over 3 years
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MEASUREMENT OF RISKS
BUT:
 Most gold mining companies do not use this delta
calculation
 No mention of the volatility of spot gold prices
 Instead, they only briefly mention that a certain
dollars per ounce change in the gold price would
result in an increase or decrease in approximately
how many dollars change in cash flow from
operations and net income.
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TECHNIQUES AND PRODUCTS
Gold producers can use:
 Future Contacts
 Gold loan
 Gold Swaps
 Spot deferred contract
 Forward sales of gold
 Put options (Insurance purpose)
ǂ To hedge themselves against the exposures
DERIVATIVE USAGE FOR GOLD PRICE RISK
Most gold mining companies use:
 Forward contracts
 Spot deferred contract
 Put and call option
 Gold lease rate swaps
Most prefer to use forward contracts as its hedging
instruments due to the introduction of SFAS NO 133/138
This allows gold producers to not consider their sales contracts
as derivative instruments as long as they are considered to be
normal sales
Gold mining firms can record the proceeds under this contract
as revenue and can be held off balance sheet until maturity,
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the date of the delivery of the gold in the future
DERIVATIVE USAGE FOR FOREIGN CURRENCY
RISK
Gold mining companies use:
 Currency forwards
 Currency options
Since gold is quoted and traded in US dollars, gold
producers with operations and investment in a large
number of countries outside U.S will be exposed to foreign
exchange rate risks
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DERIVATIVE USAGE FOR INTEREST RATE RISK
Gold mining companies ONLY use:
 Medium to long term horizon interest rate swap
Interest rate risk is not viewed as important as the gold
price risk and currency risk due to the low leverage in the
gold mining industry
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FIRM CHARACTERISTICS FACTORS
 Firm Size
 Is measured by the firm’s gold reserves representing the maximum collateral value
and the market value of assets
 It is proven that firm size is negatively correlated with the degree of hedging
 Smaller firms tend to have little negotiation power and have a higher chance of
facing higher financing costs
 Liquidity
 Is important in determining how much funds a firm can provide in terms of
emergencies
 With a large cash balance, firms will face fewer financial constraints and hardships
 So, they do less hedging as their risk management strategies
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FIRM CHARACTERISTICS FACTORS
 Leverage
 Firms with higher leverage have a higher chance of facing financial constraints
 They do more hedging in their risk management strategies
 Since gold mining industry has low leverage levels, it will not have a major impact on
the firms
 Average Cash Cost
 Is important element in determining gold mining companies’ profitability, efficiency
and productivity
 There is a positive association between financial distress and average cash cost
 Since smaller firms tend to have a higher cash cost average than large firms, they
have a greater tendency to encounter financial distress when the price of gold
decreases
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POTENTIAL HAZARDS
Gold mining companies use different derivative instruments
to hedge themselves against the risks that they face from
potential future movement in market variables
The main motives for hedging:
 To cover the total operating costs
 Remove price risk
 Enhance revenue
 Control their cash flows
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POTENTIAL HAZARD
BUT
 No assurance that outcome of hedging will be better
than the outcome without hedging
 Leave firm’s profit to be dependent solely on the
underlying productive activities
 May suffer opportunity loss
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RISKS DUE TO HEDGING
By hedging, firms face:
 Credit risk
 Market liquidity risk
 Mark to market risk
Risks associated with factors such as:
 Default by counterparty
 Costs associated with unwinding the position
 Possible restrictions on credit lines
In order to develop an effective risk management program, a
firm should make a clear statement about the firm’s risk
management philosophy
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The End
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