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Nov 2001 - Pasminco (PAS)

“It’s time to leave the Forex Gambling Game Alone”

The eventual suspension of Pasminco (PAS) on 19 September 2001, and blow-out in liabilities to A$3.4bn as some of the forex was closed out by the banks on 26 September has to be the final warning for resource companies to leave the forex or currency speculation “game” alone. All too often we have seen resource companies appear to think that trading currency is the same as trading commodities. It isn’t, it’s vastly different and generally with no observed correlation whatsoever !

PAS is not the only company to have fallen into this Venus Fly-trap, there are many examples of losses amongst the Australian base metal and gold resource companies. We can recall a quip by RIO management (who wisely never dabble) at a presentation after their acquisition of North, that “the bankers’ forex division must have been rubbing their hands with glee and popping the champagne corks each time they left North’s offices”.

So how did they all get into such a mess ?

Well it comes down to the expectation that the A$ was going to rise. Way back in June 1997, most economists expected the A$ to increase back up to US80c, but at 1am on 4 July, the Reserve Bank of Australia announced that it had sold 167t of its gold reserves over the past 6 months of which 125t had been in the month of June alone. That caused spot gold to drop US$9/oz to a 12-year low of US$325/oz. In terms of timing, the announcement could not have been made at a worse time for the gold price, the gold market had just closed for its half-day trade on 3 July ahead of the 4 July Independence Day holiday…..but that is another story.

More importantly, countries that sell their gold reserves have been observed to gradually have weaker currencies (there are many examples including now the A$), and perhaps that is why the US has so far never sold any of its gold reserves. The A$ was at US77.8c on 22 May, and by the end of July 1997 it had fallen to US73.5c and it had launched itself on the slippery-dip to regions below, reaching US65c already by the end of December 1997.

Now, w(h)ither the A$ ?

As shown in the chart below, the A$ does not look good, and briefly dipped below US48c last week with the close out of PAS’ forex, viz :

The A$/US$ Exchange Rate (January 1994 to September 2001)GDNnov01-1

The A$ had already been weak from being grouped (from an European trader’s perspective) into the other block of weak Asian currencies such as Indonesia, Malaysia, Philippines, Thailand etc, but following the recent corporate disasters, the A$ has dropped into what is called “the dog basket”, which also contains the Brazilian Real, Philippine Peso and South African Rand. As one European trader commented, “can’t run a telco, can’t run an airline, can’t run an insurance company….three strikes and you’re out…who wants the A$, let’s have the Swiss Franc”. With trading sentiment against it, the A$ has a major problem, which on the flip side is good for companies receiving returns in US$, especially gold companies….providing they have not locked in forex at higher levels (or been over-zealous with those hedging calls).

The extent of the mess that PAS had managed to get itself into, can be shown in the following table, with a possible loss of $1.5bn at US48c that could be added to the Dec 2000 balance sheet net debt of $1.4bn too, for a total net potential loss of A$2.9bn.

Pasminco’s Forex Exposure to 2005GDNnov01-2

The above table also shows that those low interest forex loans come with a “sting” too, that they are cheap provided that the A$ does not fall. WA’s three nickel laterite companies were stung with high interest rates too. We have always been wary of US$ loans having observed a South African gold company fail to reduce its loan over about 10 years, due to the falling Rand.

Admittedly PAS’ problems were not solely due to the currency fiasco, they also had the misfortune to be in the wrong metal, namely zinc which is not expected to recover until about 2003/4 or so due to Chinese dumping of zinc. The sale of the forex is wearable if the cost of producing the metal is less than what it has been sold for. A number of finance directors parted ways with their companies at the end of 2000 due to the state of the forex hedge books, but the fact of the matter is that currency speculation is totally different to commodity speculation, as many companies have learnt to their cost.

This article has been written by Keith Goode, the Managing Director of Eagle Research Advisory Pty Ltd, who has a Proper Authority with State One Stockbroking. This e-mail address is being protected from spambots. You need JavaScript enabled to view it The opinions expressed in this article should not be taken as investment advice, but are based on observations by the author. The author does not warrant the accuracy or completeness of any information and is not liable for any loss or damage suffered through any reliance on its contents

  • Written by: Keith Goode
  • Thursday, 01 November 2001