Disguised speculation

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Firms Involved

  • American Barrick

Year of the event

1993

Description of the case

Barrick American (today Barrick Gold) is a North American mining company. It became famous for its hedging program set up in the 90s, which heavily used Spot deferred contracts (SDCs). SDCs are similar to forward in the way that they define a delivery quantity, date and price at time t=0. At maturity T, the supplier has the option to roll-forward the contract at a premium or proceed to the delivery. In effect, this contract permits the firm to roll-forward losses while realizing gains immediately, increasing progressively the liabilities of the firm when the gold price is going up. American Barrick ended up winding down its position in the mid-2000s, posting a several billion loss.

Take-aways

  • One should only hedge if there are spill-over effects and externalities affecting positively the projects or assets of the company. Allowing hedging otherwise results in a perverse incentive for the firm and in an inappropriate allocation of capital.
  • Unrealized losses cannot be postponed forever, and will one day be realized.

References