Earlier this summer, Barry Cooper was asked to give a tutorial to help his colleagues on the sales desk at CIBC World Markets understand Barrick Gold Corp.'s hedge book.
As he prepared for the presentation, delving deeper into the details of the contracts that lock in the price Barrick receives for its gold, the well-respected analyst became troubled by what he found.
Mr. Cooper estimated that Barrick was accumulating off-balance-sheet costs of about $24-million (U.S.) a quarter to pay for the financing fees associated with the more than four million ounces of gold it had hedged in contracts that float with gold price movements.
The CIBC gold analyst soon lowered his recommendation on Barrick's shares to "hold" from "buy."
"A good portion of world investors will not buy Barrick because of the hedge book," Mr. Cooper told clients in a report last month.
After years of enduring stinging criticism over its gold-hedging strategy, Barrick unveiled plans this week for a massive equity issue - increased on Wednesday to as much as $4-billion from an original $3.45 billion - that will be used to largely eliminate its 9.5-million-ounce hedge position.
Among the slew of issues facing Barrick and its rookie chief executive officer Aaron Regent, none has weighed more heavily than its increasingly disturbing hedge book costs.
As the price of gold has marched ever higher amid an eight-year rally, Barrick's liabilities associated with the gold hedges have increased in kind. Lacking full exposure to the price of bullion, the share price performance of the world's largest gold producer has lagged its smaller competitors.
After taking over the top job in January, Mr. Regent embarked on a series of meetings with shareholders, who kept raising the hedging problem.
"He came to the conclusion that it had to be addressed," said an industry source close to Barrick.
Barrick plans to use $3.4-billion of the stock sale proceeds to buy back all of its fixed-price contracts and the majority of its floating spot price contracts.
But retiring the bulk of Barrick's hedge book will come at a steep price. The stock sale will dilute existing shareholders by more than 12 per cent, increasing the company's share count to as much as 982 million from 873 million. Barrick will also take a $5.6-billion charge in the third quarter as the liabilities associated with the hedges are moved onto the company's balance sheet.
Barrick's shares took a beating Wednesday on the Toronto Stock Exchange, sliding 6 per cent and decreasing the company's market capitalization by about $2.4-billion (Canadian).
Still, Mr. Regent's first major strategic move as Barrick's CEO is winning praise from long-time critics of the Toronto-based company.
Portfolio manager Charles Oliver of Sprott Asset Management Inc., says he hasn't owned Barrick shares for the better part of a decade because of the hedge book.
"I wanted to own gold companies and not companies involved in the hedging business," Mr. Oliver said. Now, he "may have to revisit the Barrick story."
Barrick has long touted its management prowess as not only a gold miner but also financial engineer. Gold hedging became an integral part of the company's strategy in the 1990s as a way to lock in gains amid flat or declining gold markets. Guided by its larger-than-life founder Peter Munk, Barrick once bragged in its annual reports about how much its hedging strategy was adding to the bottom line.
Yet the gold bull market rally that began in 2001 and has propelled the price of gold from less than $300 (U.S.) an ounce to more than $1,000 an ounce has turned Barrick's clever gold hedges against it.
Eliminating Barrick's hedge book, however, has been no easy task. The company said back in 2003 that it would stop entering into hedge contracts, but has not been able to significantly reduce its hedge exposure until now.
Since 2004, Barrick's hedge book liabilities have more than doubled, rising to $5.6-billion from $1.9-billion. The company's $10-billion acquisition of Placer Dome in 2006 exacerbated the problem.
When gold and gold stocks began rallying last week, Mr. Regent saw a potential opportunity and began considering the possible equity issue. Underwriters were contacted on Friday, but it wasn't until gold topped $1,000 an ounce on Tuesday that Barrick decided to go ahead with the offering, according to a source close to the deal.
Blackmont Capital analyst Richard Gray called Barrick's decision a "monumental" move that will improve the "marketability and optics of the world's largest gold producer."