28/02/2006 - 21:00

Gold profit depends on how you see it

28/02/2006 - 21:00

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Are Australia’s major goldminers profitable, or not? That might seem like a silly question when the gold price is close to an all-time high of almost $A750 an ounce, but it’s not being treated as silly in the boardrooms of the miners, by their auditors, or by the Australian Tax Office.

In fact, so many external bean counters and official regulators are having a say on this seemingly simple question that Briefcase has only recently become aware that the only people on the outer are the poor souls who own the mining companies – the shareholders.

Take the 2,300 people who own shares in Equigold, one of Australia’s top five goldminers, producing around 160,000 ounces of gold a year. Last financial year their company posted a pre-tax profit of $18.9 million, and paid a dividend of six cents a share.

This year, even with the price of gold rising sharply, Equigold is in danger of posting a “loss”, and has been forced to omit its dividend, despite having more than $33 million in cash and bullion on hand and generating more cash because its cost of production is just $A335 an ounce (half the gold price).

Unfortunately, all that good news is in danger of being wiped out by a flick of the accountant’s biro. More to the point, the profit might be turned into a loss because Australian companies, including the goldminers, are being forced to adopt a new set of accounting rules, the so-called Australian equivalent of International Financial Reporting Standards (IFRS).

What this does to goldminers, who are very much the meat in a nonsense sandwich, is force them to book a loss should there be a gap between what they sold their gold for into a forward selling (or hedging) program, and what they might have received had they sold into the spot market.

But, as any goldminer will say, it is generally more prudent to lock in a profit in the highly volatile world of gold (and volatility is the key in this exercise in accounting stupidity), than to take a chance of catching a high price in the spot market – a business approach Briefcase reckons can be akin to gambling.

In Equigold’s case, the new accounting rules produced this result at the December 31 half-year.

On a simple (non IFRS base) the company produced a profit of around $15 million by selling its 81,631 ounces of gold at a price of $A607/ounce.

However, because the spot market for gold was higher than $A607/ounce, the IFRS rules say Equigold must make an accounting provision of around $A12 million, to provide for the forgone profit.

This reduces Equigold’s accounting profit to around $3 million – and makes it illegal for the company to pay a dividend because a company can only pay dividends out of current or retained profits.

To say this is a farce is an understatement. Not only has Equigold got the cash, and more is tumbling in the front door every day, but it will be paying tax on the profits because the one organisation least interested in accounting adjustments is the ATO.

To try and find a way around the accounting problem, Equigold has asked for a ruling from the ATO on whether it can make a return of capital – a sort of pretend dividend. It is still waiting on that ruling.

If there is any satisfaction for Equigold it is that it is not alone. Resolute has also flagged that it will be forced to make an accounting provision of $49 million because of a gap between the value of the gold sold and the theoretical market value. Croesus Mining says its provision will be $18 million, and Newcrest Mining, Australia’s biggest gold producer, says its hedge book is a whopping $1.33 billion underwater, which presumably means it too will need to make some sort of provision, unless its gold hedges fall under a definition of what’s called an effective hedge.

Meanwhile, on the stock market, everyone seems to be ignoring the IFRS rules. Equigold is trading strongly around $1.32, Resolute is around $1.16, Croesus struggles along at 29c, and Newcrest is down at $21.34, but that’s mainly due to problems at the Telfer mine.

While the IFRS rules are being ignored by investors (which is the sensible reaction) the real damage lies further ahead when potential investors try to work out whether to buy (or sell) a stock and they are bamboozled by a business that says its losing money in one set of books (the IFRS set) and making money in another (the ones the ATO looks at).

But the real issue is what happens when/if the gold price fall as the theoretical hedging losses become theoretical profits? Does that mean a company that is genuinely making losses has to report that it’s making a profit – talk about misleading.

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On the question of mining investments, Australia’s richest man, James Packer, must be getting a little more concerned every day about the deal done by his late father, Kerry Packer, with a syndicate of other richies who last year snapped up 16.9 million shares in the titanium and zircon miner, Iluka Resources.

When Briefcase looked in early January at the Iluka play of the Kolsen syndicate, which includes mining entrepreneur Rob de Crespigny and Melbourne businessman Ron Walker, the shares were trading around $7.90, having briefly touched $9. At those prices, Kolsen was handsomely in the money, having paid around $6.50 a share for its $110 million worth of Iluka.

A few days ago, Iluka shares traded down to $6.70, but has since recovered to $7.10, which theoretically means Kolsen is still in the money… just. The problem for Kolsen, and James Packer who owns about half of Kolsen, is the holding cost on the 7.25 per cent stake in Iluka.

The $110 million plunged into Iluka shares implies a potential holding cost of about $11 million a year, assuming a notional 10 per cent interest rate. When Iluka hit $6.70 the 20-cent ‘profit’ gap between the entry price and current value was around $3.3 million which, given that Kolsen has been sitting on its shares for around eight months translates into a theoretical book loss.

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“Nationalism is an infantile disease. It is the measles of mankind.” Albert Einstein

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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