February 26, 2003 – For months one of the most frequently asked questions that I have been receiving from subscribers is ‘Are you worried about the size of Newmont’s hedge book?‘ Until now, the answer has always been yes. We no longer need worry.
Why the change? Newmont’s 4th quarter report provided some significant new disclosures. To my mind, the worst of Newmont’s hedge book is behind it. And even more importantly, what’s left is well under control.
By way of background, Newmont had traditionally been a non-hedger, and studiously avoided forward contracts and other forms of hedging – until August 1999. For those who remember, that was one month after the $252 low reached in July, and one month before the big gold rally that began after the Washington Agreement by central banks to limit their gold dishoarding. In other words, it was one of the worst times to hedge, and that foray caused a lot of angst among Newmont loyalists – me included.
My concern was that the management change that had just taken place had resulted in a new philosophy that would turn Newmont into a hedger. Fortunately, that did not happen, but Newmont raised eyebrows again when it merged with Normandy, and acquired along with Normandy’s assets a 12 million-ounce hedge book. The other part of that 3-way merger was Franco Nevada, which for me was an important part of the deal.
I held Franco’s management in high record, and Pierre Lassonde, then one of the driving forces behind Franco, would become president of Newmont after the merger. Even more importantly, because Lassonde and other Franco management were large shareholders of the company they founded, together they would own about 15 million shares of the newly merged Newmont. Further, those shares were locked-up for two years, i.e., they couldn’t be sold so Franco management was betting with their own money that the merger would work. I always like to see that kind of management commitment.
So I was in favor of that 3-way merger (Letter No. 295, “The New Newmont“, November 26th, 2001). Franco management would have a big role to play in the new Newmont. Normandy owned some exceptional assets that were well worth buying, and I had assumed that Newmont would quickly reduce the hedge book that came along with the acquisition. But contrary to my expectations, the hedge book was reduced very slowly. And that slow pace was worrying to me, particularly as the gold price shortly thereafter began to rise.
Nevertheless, though I was worried about the hedge-book, I stuck with Newmont. Lassonde and the Franco management team had made a lot of money for their shareholders at Franco over the years, and that means a lot to me. Some may call it loyalty. But to me it was just good sense – stick with a winning team, particularly when they personally had such a huge amount of their personal wealth on the line in the new venture. Perhaps there was some blind faith on my part, but I like to call it ‘reasoned judgement’.
Anyway, I am now convinced that my judgement was well placed, after reviewing from Newmont’s 4th quarter report. And in this regard, I suggest that you read an excellent analysis of Newmont’s hedge book that was just published today by Tim Wood on Mine Web, “Gold hedging brinkmanship is here“. (www.theminingweb.com)
In 2002 Newmont reduced its hedge book from 11.5 million ounces to 6.6 million ounces, but 3.4 million ounces of these remaining hedged ounces arein an operating subsidiary called Normandy Yandal. The important point is that these 3.4 million ounces are non-recourse to Newmont. And given the fact that Yandal has only 2.1 million of reserves, Yandal has hedged 1.3 million ounces more gold than it records as its reserves.
Yes, the previous sentence is correct. Yandal has hedged 1.3 million ounces more gold than it records as its reserves. Oops. Looks like some banker’s worst nightmare.
Clearly, Newmont is in the driver’s seat because the hedge book is non-recourse to Newmont. The bullion banks that made those foolish advances to Yandal stand to lose many millions – hundreds of millions actually.
The truly amazing thing is that the bankers who made these imprudent loans to Yandal have now exercised their “right-to-break” clauses in the hedges. Tim’s excellent article explains how these clauses work. This is really funny because the bankers either don’t see that there is a freight train bearing down on them or they don’t understand that they need Newmont more than Newmont needs Yandal.
Some bankers are going to lose their jobs over that one – not to mention their shirts. Having wreaked havoc on the gold mining industry for years with ‘their master of the universe’ salesmanship of exotic hedges that are now turning toxic, the bankers’ comeuppance couldn’t be more deserved.
Now that the more glaring hedge books disasters are being exposed (e.g., look at Sons of Gwalia, one of the ‘pans’ in my Barron’s interview last September), it is only a matter of time before they all blow up. None of these books will be able to withstand public scrutiny. Their toxic hedges and commitments larger than reserves (Yandal and Sons of Gwalia are not the only two mining companies in this boat) are too destructive. All of these books will blow-up sometime this year when gold goes over $400, sending gold higher as the shorts scramble for cover.
Newmont’s hedge book excluding Yandal is 3.2 million ounces. That’s still a lot, but it is only about five months worth of production and 3.7% of Newmont’s total reserves. In short, Newmont will probably lose some money on these hedges, but this cost is small in comparison to the value of the assets that Newmont acquired in the Normandy acquisition.
Thus, the Franco team has pulled off a major coup. Hats off to Pierre Lassonde and his team.
This new information about Newmont’s hedge book is for me a very bullish development. Newmont has been on my list of top picks since I recommended buying it on October 20, 2000, when it closed that day at $13.94 per share. And this new news suggests that Newmont will stay on my recommended list for some time to come.