BUSM4160 Managerial Finance

Identify three risks faced by the gold mining company and explain the use of three derivatives that could be used by this company to control these risks.

Provide a written response to the question, in accordance with the instructions for mini-assignments.  Especially, please note that your response must be fully referenced.

• Risk of the rising dollar:there is an increased amount of risk for the gold stocks due to the string value of the dollar. A strong dollar is a good news for the US consumer that could comparatively afford an increased value in the market that is overseas but this merely means that the consumers would not be able to afford the gold which they were able to afford before. The same rule goes for the overseas countries that purchases gold since the prices of the gold is mostly expressed in dollars. The purchasers of the gold in the stronger environment will not be able to buy as much as before they were able to buy in their own currency. Hence, the amount of the gold which is sold across the world would hurt the price of the underlying commodity. In its consolation, when the value of the US dollar increases, it not only effects the price of the gold but also of oil.

But it is also true that the rising dollar would be very bad for the emerging market that is able to rely on the exports and also on the rising prices of the commodities that drives their growth. China is a very export driven economy that has witnessed shrunk in its currency which shrank to 6.2 to $1 when the same is compared with the 6.8 to $1 which was just 5 years ago. China is the major exporter of the metals across the world and sees the growth which is slower since the exports are weaker and that could dampen the consumption of gold.

Not like the traditional miners, the companies provides some upfront cash to the various mining companies which is in exchange of the % of the mineable reserves of the fold and that too a very lower amount of the fixed cost. Hence, the fixed cost of the gold is very much low and hence, is not in a position to lose the money any time in near future. That could easily affect the fluctuations that underlies the price of the gold. It would not help when there is a 60% of the revenue during the year 2014w which was derived outside the US which gets the hit of the negative effects of the translation of the currency (EY, 2017).

• Financing risk:the second biggest risk of the financing risk which is mainly the financing built out.

Mainly due to the reason that the prices of the gold have fallen to $700/oz after the peak season during the year, this does not mean that the costs that are connected with the paying for the labour maintaining the mine, expanding the mine and then completely building the mine from scratch would abate the way. With the height in the prices of the gold, the companies have been left with the dilemma of wither scraping the projects until and unless the development has bene made feasible or selling the products mainly to the asset hungry miners. These are the results that are not favourable.

The owners of the Thompson Creek Metals state that there have been more frown on the faces than the smiles over the past 3 years. This is the theisis that owns the company and this fact is still believed to be true. This was about the Mount Michigan mine which was acquired during the year 2010 with the purchase of the Terrane Metals which was thought to be a changer of the game. There has been a proved and a probable reserves which totals to about $2.1 billion pounds of copper and also 6 million ounces of gold and which shows the $1 plus rise on the earning per share of the company 4 to 6 quarters after the ramp up. The company’s budget went up in flames. The company’s cost was estimated at $750 million, and the development utility cost was much closer to the $1.5 billion. These were the extra costs that were compounded with the weaknesses with the market such as the free cash flow which was positive along with the sale of 52.25% of its interest of royalty in the Mt. Milligan mine to the none other than the total gold.

The company was left with more than 95% of the all-time high and also, is lugging in and around the $70 million in net debt for the debt to equity of 133%.

• Political risk:the third is the political risk. The main concern for the stocks of the gold is the political risk which operates in the countries or the regions that are considered to be highly unstable in nature. The dollar must be hurting the miners of gold in the country of Australian or Canada but then there is a risk which is involved in the political instability that harms the mining operations in such countries. There is not much of the gold miners which operates in the country of Africa wherein the political instability is the way of the life (Mining technology, 2017).

During the year 2012, the operations of the gold miner by the name of Anglo Gold Ashanti were halted since the mining labourers went on a strike all across the country since they were demanding a rise in their wages. This represented the increase in the underlying expenses which run the mines in the AngloGold Ashanti’s South Africa but it is also true that they cut off the third of the production of the gold which was being produced as the whole (KPMG, 2017). The company ultimately increased the wages of the labourers and they opened the mines again but the company notes that there were many of the wage increase discussions in each one of the year with the labourers and that too without the consequences. The power utility of the company was requested to increase the electricity tariffs by 25.3% which involved the previous hike which was demanded at 12.69% during the month of March (Australia mining risks, 2017).

The following are the risk hedging instruments for the sector:

Gold futures:

The producers of the gold are bale to hedge as against the falling prices of the gold merely by taking up position in the future market (The options guide, 2017). The companies are able to employ the short hedge which would lock up the prices of the future sales for the production which is currently being going on in the future.

In order to implement this hedge, the producers must sell adequate contracts of the gold futures in the market so that the quantity of the gold could be produced (research gate, 2017).

The following are some other hedging instruments that would protect the prices of gold (PWC, 2017):

• Commodities futures and options market (Comex, NYSE Liffe US);
• Forward trades and options with a bank or trading company;
• Other derivatives, including finance deals with lenders (Bullion vault, 2017).

The use of the commodities future and the option market would add some transparency to the model of pricing plus it would record all the prices that have bene traded as and when the hedge was placed. On the same, the option contracts could also be traded and there are many of the different reasons for doing the same. In the market which is stable or is declining, the company could determine to sell the calls which means writing the call option which would earn the income from the trader that buys the same (Diva portal, 2017).

References:

Bullionvault.com. (2017). Gold & Silver Hedging: The Miners' Dilemma. [online] Available at: https://www.bullionvault.com/gold-news/gold-miner-hedging-082620131 [Accessed 15 May 2017].

Caron Sugars, T. (2017). Australian Mining Risk Forecast 2017. [online] KPMG. Available at: https://home.kpmg.com/au/en/home/insights/2017/01/australian-mining-risk-forecast-2017.html [Accessed 15 May 2017].

Ey.com. (2017). Business risks facing mining and metals 2016-2017. [online] Available at: http://www.ey.com/gl/en/industries/mining---metals/business-risks-in-mining-and-metals [Accessed 15 May 2017].

Mining Technology. (2017). Breaking free: weathering the risks facing mining in 2017. [online] Available at: http://www.mining-technology.com/features/featurebreaking-fee-weathering-the-risks-facing-mining-in-2017-5731407/ [Accessed 15 May 2017].

Pwc.blogs.com. (2017). Should miners hedge? - Treasury. [online] Available at: http://pwc.blogs.com/finance_and_treasury/2016/06/should-miners-hedge.html [Accessed 15 May 2017].

Theoptionsguide.com. (2017). Hedging Against Falling Gold Prices using Gold Futures | The Options & Futures Guide. [online] Available at: http://www.theoptionsguide.com/gold-futures-short-hedge.aspx [Accessed 15 May 2017].

Writer, S. (2017). Understanding the risks - Australian Mining. [online] Australian Mining. Available at: https://www.australianmining.com.au/features/understanding-the-risks/ [Accessed 15 May 2017].

www.diva-portal.org. (2017). Hedging strategies of Swedish mining companies. [online] Available at: http://www.diva-portal.org/smash/get/diva2:643089/FULLTEXT01.pdf [Accessed 15 May 2017].

www.researchgate.net. (2017). A Reality Check on Hedging Practices in the Mining Industry. [online] Available at: https://www.researchgate.net/publication/280554088_A_Reality_Check_on_Hedging_Practices_in_the_Mining_Industry [Accessed 15 May 2017].