Stranger Than Fiction
SAN FRANCISCO -- Things aren't always what they seem on Wall Street, particularly in the gold market. That truism was glaringly evident today in the reaction to news
agreed to an $8.71 per share buyout offer from
At first glance, the deal was greeted as one might expect. Homestake's shares -- the third most active in
trading -- gained 21% as Barrick's offer represented a 31% premium over Friday's close. Barrick shares slid 4.6%, reflecting that Barrick will issue about 140 million of its shares to pay for the deal and assume $225 million of Homestake's long-term debt. Barrick said the acquisition will dilute its 2001 earnings but add to its results in 2002.
One spin on the news -- and my initial one -- was that the deal is bullish for gold stocks because Barrick's management is considered among the savviest in the industry. The purchase could be viewed as an indication that Barrick believes shares of smaller gold miners, if not the metal itself, are undervalued. The
Philadelphia Stock Exchange Gold & Silver Index
rose 0.2% today while major averages slumped, save the
Furthermore, with the
set to lower interest rates this week for the sixth time this year, recently dampened inflation fears may resurface, giving gold and related shares a boost. That'll be especially true if the central bank eases by 50 basis points.
"Now is the time for gold to start glittering," suggested Paul Kasriel, chief U.S. economist at
Northern Trust Co. of Chicago
, in a report out Friday.
Kasriel, one of the foremost advocates of
inflation's re-emergence, noted fed funds are currently about 40 basis points above the 3.62% year-over-year change in the
Consumer Price Index
, the tightest spread since 1993.
"Gold starts to come into its own as a desired asset class when you can no longer get an honest return on your money," which occurs when fed funds falls below inflation, he argued. "My guess is that some investors are starting to nibble at gold because of expectations that the funds rate will drop below the consumer inflation rate in the not-too-distant future."
Today, the price of gold rose 0.5% to $274.70. Meanwhile, fed funds futures are pricing in 54% odds for a half-point rate cut.
But as suggested above, many gold market participants weren't enthralled by the Homestake-Barrick deal.
"It's an unmitigated disaster," said one trader of mining stocks. "I see no reason to do this transaction.
Homestake could have achieved a 30% premium in the blink of an eye if the gold market hiccups."
A big reason for frustration over the deal is that Barrick is an aggressive hedger while Homestake is not. Hedging refers to mining companies selling future production at a fixed cost, in order to protect themselves against potentially lower prices.
Assuming completion of the merger, the combined Barrick-Homestake will have about 18 million ounces, or about 20% of its reserves, hedged at a minimum price of $345 an ounce.
Although that's well above spot market prices, hedging is anathema to gold bugs, who believe the practice contributes to a vast effort by central banks and broker/dealers to artificially suppress the price of gold. Some of the more aggressive conspiracy theorists accused Homestake CEO Jack Thompson, who will become vice chairman of the combined entity, of essentially selling out to the enemy.
While that's a fringe view, the first question on the conference call was about hedging, specifically whether Barrick would increase its activities to account for the newly acquired Homestake production.
Not at all, Barrick CEO Randall Oliphant replied on the call, noting the company has traditionally hedged between 20% and 25% of its reserves. "Given the positive tone in the gold market, we're comfortable where we are today, and have no plans to change" the hedged book, he said.
Meanwhile, Thompson indirectly addressed the "sellout" charge on the conference call. Agreeing to the offer was "bittersweet," he said, but Barrick's financial muscle gives it flexibility to pursue growth either through internal development or via acquisition. He lamented that Homestake didn't have that luxury as a standalone entity. Additionally, Barrick is one of the lowest-cost gold producers and rates high on most other industry measures of financial health.
"I'm a fairly large shareholder of Homestake, and if you look at our future and the options available, in our estimation our prospects are much better as part of this
combined company," Thompson said. "We're creating an exciting vehicle for people to invest
Jack in a Box
But Thompson's enthusiasm was not shared by some other Homestake shareholders.
"What's upsetting some people is that Homestake has hedged very little while Barrick is one of the worst offenders," said Jean-Marie Eveillard, manager of the $10 million
First Eagle SoGen Gold fund. "I don't want to move from a nonhedger to the worst offender."
Eveillard also expressed concern that Barrick will increase its hedging activities going forward. Oliphant's comments notwithstanding, that was one reason gold prices initially dipped on news of the deal, traders said.
Finally, the 30% premium is "theoretical" because it's based on Barrick's stock price and not a cash offer, he said.
The fund manager said he will either sell his existing Homestake position or sell the Barrick shares once the exchange is accomplished. If others follow a similar strategy, "then incidentally it should be positive for other mining companies that don't hedge" much, including
Gold Fields of South Africa
, he said. Newmont and Gold Fields, however, both ended lower on the session while Franco Nevada gained just 0.3% in
Toronto Stock Exchange
The First Eagle Gold fund, which was up 22.9% year to date through Friday, has long positions in all three (as well as Homestake).
Eveillard also manages the $1.7 billion
First Eagle SoGen Global fund, which is up 7.9% year to date and has an approximate 4% position in gold stocks.
"We've always looked at
gold as an insurance policy and after a 20-year
gold bear market, it's a cheap insurance policy," he said. "If something goes wrong to the point where financial assets get into real trouble, the upside in gold and more so gold stocks is tremendous and can offset substantial losses incurred in financial assets."
Gold and related stocks may very well be good insurance in these uncertain times. But today's action shows again that the sector is far from boring or predictable.
Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
Aaron L. Task.