Barrick Gold to Remove Hedges

On September 8th, the world’s largest gold producer, Barrick Gold Corporation (ABX), announced its plans to raise $3 billion from a share offering and use the proceeds to pay off its gold hedges. As of September 7, 2009, Barrick’s gold sales contracts -- which comprise gold hedges and floating contracts -- totaled 9.5 million ounces with a mark-to-market position of negative $5.6 billion.

To pay off the hedges, Barrick Gold has entered into an agreement with a syndicate of underwriters for a bought deal public offering for gross proceeds of about $3.0 billion, representing 81.2 million common shares at a price of $36.95 per share.

Barrick Gold intends to use $1.9 billion of the net proceeds to eliminate all of its fixed priced gold contracts within the next 12 months and about $1.0 billion to offload a portion of its floating spot price. The company expects a $5.6 billion charge to earnings in the third quarter due to a change in accounting treatment for the contracts.

Gold hedges are futures contracts that obligate a company to sell the metal at pre-agreed prices. Although these hedges guarantee certain cash flows, they often commit metals producer to ship the gold at prices lower than the current spot price.

Barrick's decision to pay off its hedges is based on a bullish outlook for gold, prices of which rose to above $1,000 per ounce, highest in the last seven months. The weak US dollar, continuing low interest rates and inflation have dampened returns on holding cash and other liquid investments, driving investors to gold as an alternative source of investment. This in turn has fueled the rise in gold prices.

Last year, Newmont Mining (NEM), the Denver-based gold company, had eliminated its entire 1.85 million-ounce gold hedge position foreseeing a rise in gold prices. The company had issued new equity and divested its non-core merchant banking business to eliminate the hedges.

To get maximum exposure to spot gold prices, another gold producer, AngloGold Ashanti Ltd. (AU) also undertook an extensive restructuring of its hedge book in July this year, reducing its overall commitment by about 1.4 million ounces.

We maintain our Neutral recommendation on Barrick Gold.

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