toxic hedges

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    By Steve Maich Financial Post (National Post), Canada [email protected] March 4, 2003

    After months of wondering what nasty surprises might be lurking in the hedge books of the world's major gold miners, the market is now getting a look at the industry's first bonafide hedging disaster.

    The situation now unfolding at Newmont Mining Corp.'s Yandal project in Australia is enough to send a chill through any investor who's ever wondered what might happen if a heavily hedged producer lost control of its derivatives exposure. In the case of Yandal, Newmont might be forced to walk away from an otherwise profitable mine that produces about 650,000 ounces of gold each year.

    Standard & Poor's cut its credit rating on Newmont's Yandal operations by three notches to junk status yesterday, after reviewing the project's hedging exposure, released by Newmont last week. The project's credit rating now sits three levels below investment grade, and its outlook has been lowered to "negative" from "stable."

    "Without support from Newmont or a material change in current conditions, it is unlikely that Newmont Yandal will be able to pay its 2005 settlement exposures," S&P analyst Thomas Watters said. "With this additional information, it increases the uncertainty surrounding parental support [from Newmont]."

    Even by the gold industry's relatively aggressive standards, Yandal's derivatives exposure is stunning. The unit has 3.4 million ounces of gold committed through hedging contracts that had a market value of negative US$288 million at the end of 2002.

    That would be a problem for any major producer, but the situation is particularly dire for Yandal because the development's total proven and provable gold reserves are just 2.1 million ounces. In other words, the project has, through its hedging contracts, committed to sell 60% more gold than it actually has in the ground.

    Making matters worse, the mine's counterparties can require Yandal to settle the contracts in cash, before they come due. In all, about 2.8 million ounces are subject to these cash termination agreements by 2005, which could cost the company US$223.7 million at current market prices.

    With insufficient gold to meet its obligations, and just US$58-million in cash to make up the difference, bankruptcy may be the only option available to Yandal, analysts said.

    Comparing Yandal's reserves to its hedging liabilities "suggests that the Yandal assets may be worth more dead than alive," CIBC World Markets analyst Barry Cooper said in a report to clients.

    All this is raising even bigger questions about the impact that the Yandal situation might have on the industry's other major hedgers. Companies such as Canada's Barrick Gold Corp. and Placer Dome Ltd. have lagged the sector's strong rally of the past year, largely because many investors and analysts distrust the companies' derivative portfolios.

    A high profile blow-up for Newmont, the world's biggest producer, could "send bigger shock waves" into other hedged companies, as investors try to avoid the uncertainty surrounding derivatives, CIBC's Mr. Cooper said.


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