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XMFSinchiruna (26.56)

The Incredible Ironly of Paltry Gold Profits



August 05, 2009 – Comments (7)

What will it take for gold miners to finally reap those blockbuster earnings we would expect when prices are this high and costs this low?

This article explores the nagging issue of currency losses and derivative hedges as they relate to gold miners, and the stinging irony that they present in an asset class sought for their very protection from those same financial ailments.

On the surface, Yamana had an amazing quarter: reaching record production as projects are ramping up nicely, achieving costs of just $213 per ounce after silver and non-copper base metal credits, keeping copper costs below $1 per pound, and divesting higher-cost projects deemed outside the core. And yet, the adjusted earnings of $94.9 million that so delighted the analysts with a 44% beat is not the number that comes home to roost with shareholders. No, net earnings were just $9.6 million ... 90% lower than the adjusted earnings.

Something is clearly wrong when 90% of your earnings are disappearing to these types of unrealized losses and foreign exchange impacts. Shareholders deserve to know more about what to expect on this front going forward, and how a repeat of such enormous quarterly impacts can be avoided.

Don't get me wrong ... I still think Yamana is one of the very premier choices in the gold mining sector, but these results provided a perfect example to discuss some important matters that have been bothering me about the miners for some time. They might be unhedged with respect to gold production, but as long as shareholders have to withstand derivative and currency losses on this scale, they might as well be hedged ... the result is the same.

I would love to see some accounting that indicates how the quarter would have turned out without any hedges whatsoever (i.e. if the company had engaged in no risk management techniques whatsoever). Indeed, a retroactive analysis going back several quarters would be fascinating. I think the cumulative drag of derivatives and ineffective mitigation of currency fluctuations have held the miners back significantly during the past year.

To know your miners, make sure you know their hedging activities.



"The weakening U.S. dollar reduced Yamana's second-quarter net by more than $60 million, including foreign-exchange losses and revaluation of future tax expenses. Fools will appreciate the stinging irony of investments conceived as shelter from a falling dollar having their returns ravaged by that very outcome. Naturally, Yamana hedges against currency fluctuations using derivatives."

"Yamana holds interest-rate-swap derivatives with a notional value of $444.8 million to reduce variability on an adjustable-rate debt facility. The stark irony of investors fleeing the impact of the global derivatives meltdown through exposure to gold miners -- only to find their earnings assailed by yet more derivatives -- is not lost on this Fool. All told, unrealized derivative losses for Yamana have totaled $81.8 million this year."

And here is the bottom line:

"I continue to believe that patient Fools will experience robust leverage to increases in gold prices. The remaining obstacles, it would appear, are the very same challenges plaguing the rest of the financial system: toxic derivatives and the crashing dollar."


Discuss, and Fool On!


7 Comments – Post Your Own

#1) On August 06, 2009 at 2:55 AM, portefeuille (98.85) wrote:

not buying insurance is always a great thing until something hits.

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#2) On August 06, 2009 at 7:03 AM, XMFSinchiruna (26.56) wrote:


You missed the point, dear Fool.

Something did hit ... if the massive, counterintuitive fluctuations in the dollar exchange rates over the past year, the violent variability in copper and other base metal prices, and the global credit crunch didn't represent "something hitting", then what exactly qualifies??

Any "insurance" bets that did not pay off handsomely under these circumstances was indeed no insurance at all.

Hedges are casino bets, not insurance. Hedging through derivatives carries the added risk of a frozen marketplace unable to sustain the par value of underlying "assets". 

Gold miners, especially, could have been expected to foresee the dollar weakness and "hedge" properly by investing in physical gold rather than derivatives. Now THAT would be insurance!

Are you listening, gold mining CEOs?? Can you hear me now, Peter Marrone? If you want to hedge against the impacts of a falling USD as your USD revenues have to be converted to local currencies to pay expenses, your shareholders will back you up if you decide to use physical gold holdings as a hedge and scrap the use of derivatives altogether. Shareholders long for simplicity of accounting, and predictability of earnings success ... they will flock to you if you remove these toxic elements from the balance sheet.


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#3) On August 06, 2009 at 9:42 AM, StopLaughing (< 20) wrote:

AUY is poorly managed. They are speculating instead of mining. And speculating wrong with superior market intelligence.  I bought them for an inflation hedge and they manage to turn themselves into an inflation casualty.

I am making more off of CDE which is supposed to be a dog.

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#4) On August 06, 2009 at 10:28 AM, bothisellhigher (29.12) wrote:

How does Yamana (and others) "remove these toxic elements from the balance sheet?"  Is there any indication that they are even trying to... And, I just don't get why, if your company's very product is in and of itself a "hedge" against a falling USD why you would take on the added risk of huge investment in derivatives in the first place.  Were the profit potentials that irresistable to a gold miner who really wasn't thinking "hedge" but was thinking greed and huge profit and gigantic "bonus" like all the banker slimeballs?

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#5) On August 07, 2009 at 12:04 AM, MGDG (33.03) wrote:

Sinch, I glanced at a few of the Juniors and 3 stood out in terms of stock price appreciation from the Oct. 08' lows. They were JAG & EGO with gains of 350% and IAG gaining 400%.

I took at quick look at earnings on IAG as they were released today and they report net earnings of $44.1 M and operating cash flow of $38.9 M. So it would seem most of their earnings are from mining Gold.

On the surface it seems over priced at his level. Maybe on the weekend I'll dig into a few of these and see where and how earnings are being held down. If I were to buy any miners, I would want them completely unhedged, as I would be making a trade based on where I believe the price of Gold was heading.

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#6) On August 08, 2009 at 3:40 PM, kstarich (28.97) wrote:


Maybe you could do a new blog update on the miners who have strong earnings and are not involved in hedging.  I was wondering why AUY seemed to be stuck.

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#7) On August 08, 2009 at 9:15 PM, ChrisGraley (28.68) wrote:

The insurance isn't supposed to be the catastrophic event.

They made the same mistake that a novice investor does. They tried to time the market. They would have looked like kings if gold had tanked, but now they have egg on their faces.

They could use a financial exec from the oil companies to properly hedge risk.

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