1. GOLD

2. GOLD MINING INDUSTRY
Demand & supply of gold
Production of gold
Market dynamics
Large producers
Firm cost structure and revenue composition
Firm strategies going forward

3. DEMAND & SUPPLY OF GOLD
The market dynamics of gold are dominated by short-term 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.

4. Demand & Supply of Gold

5. How Gold is Mined Exploration Exploration Drilling Blasthole Drilling
Blasting
Underground Mining
Ore & Waste Haulage

6. How Gold is Mined Heap Leaching Mining Oxidization Leaching Stripping
Electro-winning

7. How Gold is Mined
Smelting
Gold Bullion
Refining
Reclamation

8. 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.

9. 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.

10. Market Dynamics: Gold Prices

11. 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.

12. LARGEST GOLD PRODUCERS BY MARKET CAPITALIZATION
Companies:
Anglo American PLC
Newmont Mining Corp.
Barrick Gold Corp.
AngloGold Ashanti Ltd.
Placer Dome Inc.
Gold Fields Ltd.
Market Capitalization:
35.87B
20.28B
13.73B
10.10B
7.76B
6.26B

13. FIRM COST STRUCTURE & REVENUE COMPOSITION
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

14. 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

15. 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

16. RISK ASSESSMENT
Three major market risks faced by firms in gold mining industries:
Commodity Price Risk
Foreign Exchange Rate Risk
Interest Rate Risk

17. 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

18. 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

19. 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
Profitability

20. 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 forward gold price & current spot price

21. 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

22. 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

23. 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.

24. TECHNIQUES AND PRODUCTS
Gold producers can use:
Future Contacts
Gold loan
Gold Swaps
Spot deferred contract
Forward sales of gold
Put options (Insurance purpose)
To hedge themselves against the exposures

25. 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, the date of the delivery of the gold in the future

26. 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

27. 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

28. 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

29. 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

30. 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

31. 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

32. 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

33. The End