Gold price traps Ashanti in hedge deal — Possibility of US$450-m loss hits gold producer’s shares

Shares in Ghanaian gold producer Ashanti Goldfields (ASL-N) plunged following an announcement that the company was facing large paper losses in its gold hedging program.

Ashanti, which was among those gold producers most heavily committed in the futures and options market, received a margin call on Oct. 5 as the gold price touched US$340 per oz. If it were to be forced to liquidate the hedge book, the loss would be near US$450 million.

Ashanti’s share price surged early on Oct. 5 when Lonmin, the London-based successor company to Lonrho and holder of 32% of Ashanti’s outstanding shares, announced it was negotiating for a friendly takeover of Ashanti. The two companies said the Ghanaian government, which owns a 20% block, was being kept informed, and Lonmin was performing a due diligence investigation.

This was followed, though, by Ashanti’s announcement that some of its lenders were entitled to margin calls on hedge instruments Ashanti had taken. The share price fell to US$5.50 from US$10.38, and was down to US$4.13 at presstime.

Ashanti’s net hedge position was 10 million oz. gold, about 7.5 times its annual production of 1.5 million oz. The book’s net value, on paper, was a negative US$450 million, which precipitated the margin calls. The company’s hedge book included forward sales, put options and call options.

Ashanti officials in New York could not be reached for comment, but a company press release said the lenders had agreed to a temporary standstill on the margin calls. Ashanti said that it was “actively reviewing . . .

opportunities to create additional liquidity” and that merger talks with Lonrho were still going on.

Ashanti argued publicly that the higher gold price substantially increased the company’s minable gold reserves, offsetting the paper loss in its hedge book. The company also said that if the future sales were allowed to proceed, production would show a sufficient operating profit at the new higher gold prices to clear off the losses.

Ashanti expects to produce 800,000 oz. in the third quarter at cash operating costs of US$214 per oz. Production was down slightly because of a weather-related shortfall at the Siguiri mine in Guinea. The company is also completing a business plan to boost efficiency at its main Obuasi complex in Ghana, its intention being to expand underground mining around high-volume shafts in the southern part of the mine.

Recently, Ashanti further evaluated the Nyankanga deposit at its Geita property in northern Tanzania, boosting the resource to more than 8 million oz. The increase comes from high-grade mineralization encountered below the currently defined open pit. Reserves at Geita still stand at 33.7 million tonnes grading 3.5 grams per tonne. The pit design shows a stripping ratio of be 4.6-to-1.

As a result of the resource increase, Ashanti will be able to lift planned production from Geita to 500,000 oz. per year. Cash operating costs should stay below US$180 per oz., though the company expects to improve those numbers by using a dedicated electrical power station.

Capital costs of US$165 million for construction include US$26 million for the power station.

In the meantime, construction remains on schedule, with first gold production expected in the third quarter of 2000. The company has spent US$13 million on exploration to date at Geita, with more planned for the fourth quarter on additional targets on the property.

The increase in the gold price has proved a mixed blessing for companies whose hedge positions committed them to deliver gold they will now have to buy at market price. Straddling strategies — balancing put and call options so that the premium paid for one essentially cancels the discount on the other — were designed to lower the cost of hedging, but, in the event prices break out, the company is faced with a choice of filling the option commitment at a substantial loss or buying it back for cash.

Exposure to rising gold lease rates also threatens some gold producers. Many have made floating-rate gold loans part of their hedge programs and are now faced with higher costs to service gold-denominated debt.

The market has singled out mid-tier producer Cambior (CBJ-T) for trouble with its hedge strategy. The company has historically been among the more aggressive hedgers in the gold business, a strategy that had made it one of the more profitable gold producers during the bear market of the past four years. Cambior shares had fallen from a high of $5.80 on Oct. 4 to $2.85 at presstime.

The company has maintained a hedge book with 2.7 million oz. — about four and a half years’ production at current rates — sold forward over the next eight years at an average US$309 per oz.

The fear in the market, though, stems from call options the company has sold on 1.9 million oz. over the period 1999-2002. The calls are at an average price of US$315, but the options on 921,000 oz. expiring in 1999 have an average price of US$287. In the extreme case, if Cambior had to fill all those calls at typical recent spot prices, the transaction might cost US$30-40 million.

Among other committed hedgers, Echo Bay Mines (ECO-T) has also been a user of call options in recent years. TVX Gold (TVX-T) and Bema Gold (BGO-T) have mainly used put options to maintain a floor price for some of their production. The most recent information available from Viceroy Resource (VOY-T) shows significant sales of calls, but at prices still well above the current spot market.