Midas commentary for February 14, 2000

9:15p EST Monday, February 14, 2000

Dear Friend of GATA and Gold:

Reginald H. Howe once again has proved himself a world-
class financial analyst and a compelling writer and
investigative reporter with the following essay, quot;The
New Dimension: Running for Cover.quot; Howe has examined
the gold calls recently purchased by the bigger gold
hedger, Barrick Gold, and concludes that they probably
are part of a desperate scheme with the gold shorts to
keep the price of gold capped.

I sure hope that Howe gets invited to Barrick's next
press conference, along with John Hathaway of
Tocqueville Asset Management. But I won't hold my
breath.

Please post this as seems useful -- like, everywhere,
please!

CHRIS POWELL, Secretary/Treasurer
Gold Anti-Trust Action Committee Inc.

* * *

The New Dimension: Running for Cover
By Reginald H. Howe
www.GoldenSextant.com
February 14, 2000

- - -

NOTE: In preparing this commentary I have received much
helpful advice and assistance from Patrice Poyet
(poyet@cstb.fr), qui s'intresse aux marches en France
et l'exterieur, and from Sunil Madhok
(skmoi@emirates.net.ae), whose writings on gold in
India have appeared at Gold Eagle. Merci beaucoup
chacun d'eux. Any mistakes, of course, are mine.

- - -

Last week Barrick made its much-anticipated
announcement on hedging. According to its press
release, Barrick during the last quarter of 1999: 1)
reduced its exposure on call options written to 2.7
million ounces (versus 4 million as reported at its
website at the end of the third quarter); 2) stretched
out the delivery schedule on its its spot-deferred
contracts, which now cover a total of 13.6 million
ounces (versus 14 million as reported at its website at
the end of the third quarter); and 3) engaged in quot;an
important new dimensionquot; by purchasing call options on
6.8 million ounces.

The release further states that the new purchased call
options quot;cover 100 percent of production from March 1,
2000, through 2001,quot; at strike prices of $319/oz. in
2000 and $335/oz. in 2001. Thus Barrick's hedging
program, according to the release, quot;has been reduced
from 18.8 million ounces at the end of the third
quarter to a net 9.8 million ounces at year-end 1999.quot;

While the numbers do not fully jibe with those at its
website for the prior quarter, the net reduction in
Barrick's hedge book of some 9 million ounces consists
of 400,000 ounces delivered under forward contracts, a
reduction of 1.3 million ounces in written calls, and
the purchase of new calls for 6.8 million ounces. In
discussing this information with analysts, Barrick has
apparently revealed three further facts of
significance: 1) the new purchased calls are for cash
settlement only (CSO); 2) they were sold to Barrick by
one or more bullion banks, whose identities are
confidential; and 3) the total cost of the purchased
calls was $68 million. An article in The New York Times
last Sunday

(www.nytimes.com/library/financial/investing/021300invest-gold.html)

states that the premium (average?) for the 2000 calls
was $6/oz. and for the 2001 calls $12/oz.

In fairness to Barrick, the existence of a CSO
provision appears ambiguous based on its press
releases. The February 7 release states that the
purchased calls give Barrick quot;the right, but not the
obligation, to purchase gold.quot; Its February 8 release,
however, made after the conference call in which cash
settlement was discussed, states that quot;every dollar
abovequot; the strike price quot;will now be added to Barrick's
floor price of US$360 per ouncequot; in 2000.

Barrick's reference to the quot;netquot; position of its
hedging program is somewhat misleading. Indeed, it
fooled at least one gold analyst into asserting that
since Barrick was able to close nearly half of its
hedged position in the fourth quarter without pushing
up the gold price, the gold market is not as short as
Frank Veneroso and others claim, and Barrick is not
quot;trappedquot; by its hedge book. However, buying calls, and
particularly CSO calls, is not the same thing as
closing forward contracts. Had Barrick bought physical
gold in the amount of its calls (6.8 million ounces or
212 tonnes), it almost certainly would have caused the
gold price to rise substantially. What is more, the
very fact that it bought paper gold -- not to mention
paper gold that by its very terms is not convertible
into physical gold -- suggests that Barrick was in fact
unable to cover its forwards in the physical markets
without driving up the gold price.

Reaction in the gold market to Barrick's announcement
appeared negative. Some have noted the irony of the
positive market reaction to Placer Dome's earlier
announcement of a mere suspension of further forward
sales coupled with prospective buybacks, and the
negative reaction to Barrick's announcement of a
substantial quot;netquot; reduction in its hedge book. But
there is a quite rational explanation: While I was
asking who sold Barrick the calls, traders were asking
what Barrick would do with the calls. Specifically,
would Barrick delta hedge against the calls by going
short at or about the strike prices, thus making them
serious resistance levels?

Writers (sellers) of naked options (puts and calls)
typically limit their risk by delta hedging against
their exposure. Delta hedging is described by
mathematical formulas and requires quick, reliable
access to a liquid market.

To oversimplify, let's assume I write a gold call with
a strike price of $300 when gold is trading spot at
$250. As the gold price rises, I will buy gold in
increasing increments so that when the spot price
reaches the strike price I am 50 percent covered. If
the price keeps rising, I will continue to buy in
decreasing increments until I am fully covered at an
average price equal to the strike price.

Of course, in the real world the gold price will
fluctuate, but the formulas tell me for each price
exactly how much gold I should have as cover, and I
keep adjusting my cover accordingly.

But note: The purpose of delta hedging by an option
writer is to prevent loss and keep the premium received
as profit. (For more on delta hedging and derivatives
generally, see www.finpipe.com/derivatives2.htm.)

Now let's suppose that I am the purchaser of gold calls
for 1 million ounces at $320. My risk is limited to the
premiums I paid for the calls, and I may choose simply
to hold them as a bet (or hedge) on a rising gold
price. But if I am an active trader with quick,
reliable access to the physical or futures markets, I
can also use my calls to backstop a trading strategy
designed to profit from shorting gold in a delta hedge
whenever the spot price is at or near my strike price.

That is, if gold is at my strike price, I can sell
500,000 ounces. If my sale, especially when combined
with others doing the same thing, knocks the price
down, I try to cover quietly at lower prices, book my
profits, and wait for another chance to do the same
thing again. That's a successful short sale. What is
more, as long as I am successful, I can keep repeating
the process until the expiry of my options. Thus, the
purpose of delta hedging by an option purchaser is to
earn a profit.

But suppose I don't succeed and the gold price does not
return below my strike price. There are two
possibilities. First, increased volatility may cause
the value (price) of my calls to rise by more than the
increase in the underlying gold price, so that profits
from the sales of my calls would more than offset the
losses on my short positions. If so, despite my
unsuccessful short sales, I can close out my positions
at a net profit. Alternatively, in the absence of any
possibility for profit, I can cover my shorts with my
calls at no net additional cost to myself since I have
delta hedged.

Of course, in either of the two unsuccessful short
situations, I would also like to recover the premium
paid for my calls if I have not already done so through
successful short sales. But in any event my losses
should never exceed the premium amount I was prepared
to risk in the first place.

What seems to have rattled traders, then, is the
possibility that Barrick has been recruited to the
short side with at least 100 tonnes of ammunition for
use in a delta hedge, and that the $319 and $335 levels
will be strongly defended by Barrick and others,
including its bullion banker sellers.

And my questions regarding who sold Barrick the calls,
who might be backstopping them, and what is really
going on here become even more intriguing.

If the calls are cash settlement only, several
inferences about them would follow. It is very unlikely
that they would be covered calls written for income by
a central bank or other big holder of gold. Rather,
they almost certainly would have been written either as
a short-side speculation or, and in my view far more
likely, to support short-side speculation by others. In
the latter event, they are almost certainly backstopped
by someone with very deep pockets who has an interest
in capping the gold price and who therefore is unlikely
to delta hedge them even in the futures (paper)
markets, since doing so would partially negate the
short sales of others. That can only be someone
prepared to accept a $680 million loss for every $100
over the strike price. Whomever it is, Barrick
apparently believes that the financial resources
ultimately backing the calls are adequate to the task.

Another possibility is that the calls were written as
CSO calls precisely because there is not enough
liquidity in the physical markets to delta hedge them.
But if so, it is hard to imagine any reason for writing
them other than to facilitate capping the gold price,
or at least to keep Barrick from trying to cover in the
physical markets and thereby drive up the price.

Unfortunately Barrick has not provided sufficient
details on its purchased calls to calculate with any
precision the company's implied volatility under Black
Scholes. Having such a figure, it would be possible to
compare the implied volatility of Barrick's calls with
the implied volatility of similar COMEX or other market
traded calls to see whether Barrick paid the level of
premium associated with a typical arm's length
transaction. But even absent that evidence, there is
much to suggest that its purchased calls may be subject
to other special conditions.

Unlike most purchasers of calls, Barrick can by its own
actions affect the price of the underlying asset.
Whoever wrote the calls appears vulnerable to an effort
by Barrick to cover its forward obligations, thereby
also driving up the gold price. Done cleverly,
especially in combination with delta hedging its
purchased calls, Barrick might cover some significant
chunk of its written calls and forward contracts
without driving gold over $360 -- its claimed 2000
floor price -- at a profit or small loss. Then, more
than making up the losses on its remaining forward
obligations with the profits on its purchased calls, it
could glide smoothly into a gold bull market, leaving
its bullion bankers holding a bag of shorts.

Accordingly, it is reasonable to assume that either: 1)
the writers of the calls hold enough of Barrick's
written call options and forward contracts to ensure
that Barrick cannot act in this fashion; or 2) the
calls contain restrictions on Barrick's ability to
cover further, or require that Barrick maintain some
minimum ratio between its purchased calls and its
delivery obligations under written calls and forward
contracts such that its incentives continue to rest on
the side of at most a slow, controlled increase in the
gold price.

The description of the calls in Barrick's February 8
press release is consistent with Alternative 1) above.

Yet another possibility is that Barrick does not really
control the purchased calls but is only entitled at
maturity (whether they are American- or European-style
options is unknown) to the appropriate cash payments.
It may also be subject to further conditions -- among
others, refraining from certain actions that might
drive up the gold price. In this event, the bullion
bank or banks that sold the calls may be able to use
them at their own discretion to delta hedge from the
short side, whether for Barrick's account or their own.

Indeed, it is not impossible to imagine a deal where
the bullion banks get the profits from successful short
sales, Barrick gets the profits on exercise when and if
the short sales are unsuccessful, and whoever (the U.S.
Treasury Department's Exchange Stabilization Fund?) is
ultimately backing the calls has a double obligation:
1) to pay Barrick in full on exercise; and 2) to pay
the intermediary bullion banks on exercise, but subject
to partial credit for any profits they may have made on
successful short sales.

In any event, that Barrick bought options on paper gold
-- virtual gold -- from someone who is either crazy or
possessed of very deep pockets and a strong desire to
cap gold suggests: 1) that the physical gold markets
are so tight that Barrick could not cover in physical
metal; and 2) that its so-called quot;new dimensionquot; --
purchased calls -- is nothing more or less than Barrick
running for cover.

Market action at its strike prices -- $319 and $335 --
could be ferocious. With a major breach running toward
$360 -- Barrick's 2000 floor price and the level where
many think the gold banking system might implode --
Katie, bar the door.

God made gold the king of money. When He made the king
of beasts, He painted him gold. The lion's would-be
victims know to run for cover, and when none is at
hand, to keep running, and to dodge, feint, bob, and
weave in hopes of shaking the golden beast.

Barrick's instincts are no less sound than those of the
zebra or the gazelle. And watching Barrick run from a
gold panic partly of its own making promises to be good
sport, unless perhaps you are a Barrick shareholder. In
that case, Barrick's hedging program is exactly what
Randall Oliphant, its chief executive, says: quot;It is not
a theoretical concept; it is about real money.quot;

But is real money something that Barrick and other
heavily hedged mining companies know anything about?