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Neither a borrower nor gold lender be

By John Dizard
Financial Times
Thursday, June 5, 2003

The religious war in the gold market reached a climax
this week with the announcement by Newmont Mining
that all but one of the gold lenders to its Yandal mines
in West Australia had agreed to take 50 cents on the
dollar to liquidate their claims.

Newmont's buyout offer, which effectively saves the
Yandal operation $77 million, is a stunning blow to the
gold banking business.

For the past two decades, gold mines have been
developed using the gold lending market. Roughly
speaking, banks borrow gold from central banks and
lend it to mining companies. The mining groups sell
the gold, use the capital to develop mines, and pay
the loans back from their production. Since gold
interest rates are far below rates for borrowing in
dollars or other main currencies, this has been a
cheap way to build capacity.

But some gold investors, along with some gold mines,
have believed that when mines "hedge" their gold
production by borrowing, then selling the gold, they
depress the price and cannibalise their ability to profit
from future price rises. The "hedgers" believe they are
only following prudent practice for commodity producers.

This hasn't been a gentlemanly dispute. Newmont, now
the biggest gold producer, has become the leader of the
anti-hedging group. It acquired Yandal when it bought
out Normandy Mining. Yandal, which is comprised of
three mines in the Western Australian desert, has
repeatedly seen its ore reserve numbers reduced by
management, the engineers, and the accountants.

According to Newmont, the most recent and relevant
numbers showed proven and probable reserves of 2.12
million ounces at the end of last year, against which
3.5 million ounces of gold had been sold in hedge
contracts. As a quick pass with a supercomputer will
show, 3.5 million is larger than 2.1 million. Therefore
the hedge contracts were insupportable.

Since the mine's finances are not guaranteed by
Newmont, and Newmont doesn't feel like bailing out the
banks voluntarily, the banks have no choice but to
accept essentially an out-of-court bankruptcy workout.

Not so fast, say the gold bankers. Newmont is perhaps
not being entirely straightforward in using the "proven
and probable" reserve numbers. "The relevant number is
the one for the total resources," says a gold lender.

In any event, when one of Yandal's gold banks decided
last month that it wanted to call in its gold loan, Newmont
decided to "play chicken with the banks," in the words of
another banker.

So far, all but one of Yandal's gold banks have accepted
the 50-cents-on-the-dollar deal. The alternative would have
been to take their chances in court. On the face of it, they
might have done better going that route. Since they
should be secured lenders, they should have had a good
chance of getting all their money back, admittedly after a
lot of lawyer time and, more depressingly, trips to the
western Australian desert to visit their new property.

However, we may get to see some further twists in the
story, since Newmont will not close on the buyout offer if
it is not accepted by all the banks, which has to happen
by June 21. One holdout means the exchange, and with
it a related buy-back of a bond issue, could be junked.

In the meantime, the gold lenders to Yandal had to
balance their books and offset their newly naked short
position by buying up gold over the past few months.
That 2.5 million to 3.5 million ounces of gold demand
has helped run the price up to its recent peak of around
$390. Since the uncollectible loans have been covered,
demand and the price have slumped.

"[Newmont] turned this into a battle of wills with the
bullion banks," says one banker. "They paid over the top
for a dry hole and got the money back from the banks."

Few doubt that miners will find it far more difficult to
borrow gold on the same good terms they had before.
Banks will want much tougher documentation. Among
other points, they will want to make sure that all gold
lenders are treated on the same terms. They will want
to make sure reserves numbers are real. They will be
reluctant to do project financing, or off-balance-sheet
financing, of new mines.

That means mines will have to be developed with equity
financing or the security of a mining company's entire
balance sheet and cash flows.

Even the gold bulls think it likely that the gold price
could fall back for a while, as gold lenders have probably
finished covering their Yandal position.

There may have been a 1,000-tonne swing in gold
demand over the past year caused by hedge buy-backs.
That would explain much of the price rise. Any future
price rise will have to come from a revival in real investment
demand for gold. The bulls hope that will come from new
exchange-traded gold bullion shares.

The bears, and the bullion banks, think the gold bugs
and Newmont have made a massively wrong call.