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Barrick's Silver Bombshell

By: Theodore Butler

-- Posted 19 February, 2003 | | Source:

On February 12, Barrick Gold issued two press releases. (Both can be found at One announced the firing of its current CEO, and his replacement, due to poor financial performance, especially its stock performance. The other press release concerned its fourth quarter earnings and details on the hedge book. While there has been ample discussion and numerous articles on the gold hedge book, it appears that a blockbuster announcement on silver in the press release has gone unnoticed. And since Barrick is one of, if not the largest, silver short in the world, their announcement that they intend to deliver against and to buy back and cover their entire silver hedge book (not gold), could have profound impact on the market.

About four or five years ago I wrote about Barrick Gold and the influence their forward selling had upon the price of gold and silver. I held them up as the example of manipulation of gold and silver through leasing and short selling. I complained about them to the Securities and Exchange Commission, the Commodity Futures Trading Commission, Barrick's own auditors, and, of course, to Barrick itself. I think I was the first one to raise the issue publicly. I say this not to boast, but only to give full disclosure and perspective in what I have to say about Barrick today.

My main gripe was about Barrick's role in hedging. Legitimate hedging did not allow for years of future production to be dumped on the market in physical form, as leasing and forward selling permitted. Further, I complained that selling short years of production forward, regardless of the price, was so stupid as to defy description. Most of my writing about Barrick took place while gold traded under $300, and even under $275. My point was that legitimate hedging doesn't take place at prices approximating the cost of production. Shareholders are not well served by the company eliminating the profit potential from rising gold prices. Had Barrick taken this advice to cover their gold shorts at those price levels, they would have come out as heroes, and their shareholders would have benefited greatly. In addition, had Barrick covered their gold shorts while prices were low, they would have been in position to hedge at much higher prices (over $100 higher) and lock in real profits for their shareholders. Instead, they actually increased their short position and have suffered the consequences.

While they obviously made a serious mistake in not closing out their gold shorts while prices were low, Barrick is not run by stupid people. As one of the largest gold miners in the world, they get advice from what are thought to be the best minds in the financial world. They appear to be learning from their mistakes in gold, based upon the unambiguous nature of what they say about their silver hedge intentions. In the Notes to the Financial Statement section of their earnings announcement, in a section entitled, "Spot deferred silver sales contracts and written silver call options", Barrick stated the following, on Feb. 12:

"Spot deferred silver sales contracts have the same delivery terms and pricing mechanism as spot deferred gold sales contracts. A group of these contracts totaling 14.3 million ounces of silver are accounted for as normal sales contracts, as it is probable that we will physically deliver silver production into the contracts. For a separate group of contracts totaling 21 million ounces, we intend to financially settle these contracts, and therefore they are accounted for as derivatives under FAS 133."

In following Barrick closely for many years, I can tell you they have never made such a statement before. In addition to delivering this year's (maybe entire) silver production against the hedge book, Barrick intends to "financially settle" the rest of the silver short hedge book. That's big news. So big, that had they made the same announcement about gold, it would be all anyone talked about. But they didn't say that about gold, only silver. And I think there is a very good reason for that, namely, that Barrick finally understands the real risk of a big silver short position.

Barrick, in addition to being the largest gold, and probably largest silver short in the world, is also the "soul" of physical forward short selling. They were the pioneers and are the leaders and pacesetters of gold and silver hedging. They wrote the book. Everyone else followed their lead. For Barrick to come out and state their intention to cover their silver shorts is both profound and intelligent. It is likely that other silver shorts, including other mining company shorts, will also see the light and follow Barrick. That could have a big impact on the silver market. And it would be in the best interests of the other shorts to follow the leader, precisely because Barrick's move makes good sense.

Barrick has good reason to have decided to get out of their silver shorts, the same good reason for an investor to buy silver - the risk/reward ratio. There is not much real room to the downside in silver nor potential hedging profits or protection. Silver prices have gigantic upside potential, $50 or $100 higher, or more. Dimes to the downside, dollars to the upside is not very inviting to a short seller.

Barrick's directors and risk control people took a close look at their overall liability, in light of their poor performance, and obviously concluded that silver presented a problem. A 46 million ounce silver short position ( there's almost 11 million additional ounces short via written call options) offers scant protection for Barrick to the downside, maybe $20 million on a decline in silver prices. But, at $25/per ounce, Barrick would be out a billion dollars on their silver hedge. At $50, they'd be out $2 billion, at $100, $4 billion. Smart management does not make bets that offer so little in reward with risk that might break the bank. Barrick has wised up. It's about time.

The reason Barrick has decided to close out their silver shorts also might have to do with the cost of doing so. Because silver is so dirt cheap, it would not take relatively large amounts of money. While Barrick is being intentionally cryptic in saying they will "financially settle" a large chunk of their silver short position, even if they paid cash for all 35 million ounces held physically short, that comes to $175 million, something Barrick could afford.

With the leading silver short saying, in effect, that they will short no more, the manipulation that has existed for decades is losing a key sponsor. Who will take their place, with $4.50 silver and everything saying buy, don't sell? There is the very real possibility of a domino effect here. Putting aside the deficit and real supply/demand fundamentals, if the other shorts wake up, as Barrick has, and go to cover their shorts and short no more, that alone could drive silver to $100/ounce.

Also, I can't help but recall the correspondence, over the past year, with the CFTC and the COMEX, about me questioning the legitimacy of the giant and concentrated silver short position. I said show the me the real silver or legitimate hedging it represented. They couldn't show the silver, because it doesn't exist. Now the largest silver short is clearly saying they don't wish to be hedged anymore. I ask the CFTC and COMEX, with Barrick renouncing silver hedging, who is legitimately hedging silver?

I want to congratulate Barrick for coming to their senses by terminating their silver hedges. All Barrick shareholders should be dancing with glee. They will no longer be in harm's way because of a silver price explosion. Many silver investors already know what Barrick now knows. Soon, the whole world will know.

-- Posted 19 February, 2003 | |

This article is brought to you in part by Investment Rarities Inc.


Last Three Articles by Theodore Butler

Warnings Ignored
4 September, 2009

The Voice Of The People
25 August, 2009

Walking the Walk
20 August, 2009

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