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Opinions of Saturday, 23 February 2002

Columnist: Taylor, Raymond

ASHANTI: A Hedge Too Far

Mr. Sam Jonah the chief executive of Ashanti referring to the financial debacle that hit the mining group stated "I am prepared to concede that that we were reckless. We took a bet on the price of gold. We thought that it would go down and we took a position". This we are sorry to say was not a good enough explanation and more of a display of shear arrogance. The firm went through a mauling only to escape battered and bruised by not only the markets but also the firms bankers led by Goldman Sachs. Had Mr. Jonah been the Chief Executive of a Japanese listed company, he would have done the honorable thing and handed in his resignation letter in Tears! My intention in is to explain why this should have been his response.

In the last week of September 1999, the price of Gold jumped by $11 to $281.10 per ounce in London. This was after 15 European central banks gave a surprise announcement on Sunday 26 September 1999 to curtail the sale of gold from their official reserves for five years. This decision had come in response to the Sharp fall in the price of gold since the UK Treasury had decided in May 1999 to sell 415 tonnes from its reserves. The decision not to sell was welcomed within gold mining circles. A rise in Gold's price it was argued will help gold mine operators hit hard by the collapse of the bullion price earlier that year. The bullion price as at 29 September 1999 was $281 per ounce nearly $30 higher than it was in August when it had reached its lowest for 20 years at $252. The price of gold was to surge to a new high amid volatile trading conditions. On 6 October, the price was fixed at $362.25 per ounce in the morning, before sliding back to $325.50 at the afternoon fix. This unexpected rise in the price of gold resulted in an increase in the long-term value of most mining companies.

Ashanti with reserves of 23 million ounces was in theory supposed to benefit from this price increase. However, this was not the case. The rise in the gold price put a negative value of $450 million on its derivative hedge book “contracts the company has entered into to reduce its exposure to a falling gold price” of a net 11 million ounces. Gold market participants questioned why Ashanti had hedged such an unusually high proportion of its total reserves. The negative value of $450 million on Ashantis' hedge book meant that its 17 hedgebook counterparties (banks with which Ashanti transacted its derivative business) could call margin deposits of $150 million. Further increases in the price of gold, could result in even larger deposits being called. If the counter parties where to decline to call margin and allowed the contracts to run to maturity, Ashanti could satisfy them with physical gold it had mined.

However, Ashantis' balance sheet was excessively stretched. It had over the last 5 years embarked upon a substantial capital expansion program. The firm had sought to turn itself into a Pan-African gold producer having acquired mines in Ghana, Guinea and Zimbabwe.

Ashanti in 1998 had produced 1.7 million ounces of gold and this was in recent years predicted to reach high of 2 million ounces of gold when its new Geita mine in Tanzania came on stream. The fall in the price of gold forced Ashanti to reign back its expansion plans. The main reason being Ashanti had made acquisition for debt rather than equity. Aware of this financial situation, and the potential associated liquidity problems, Ashanti had sought to strengthen its finances through a merger with another gold mining group. Thus on 5 October, Lonmin (a rump of the former Lonhro group) and Ashanti confirmed that they were in merger talks. Lonmin at that stage already owned 32% of Ashanti. As to whether this was a merger or a take-over was open to questioning. Reports had indicated that the two companies had been in discussion for some time, and Lonmin was yet to decide whether to make Ashanti a merger offer. Fred Ohene-Kena then Minister for Mines and energy commenting on the Lonmin Merger had stated "such a merger will enable AGC to become a major entity and have a competitive edge over other mining companies".

Thus, from the point of view of the Ashanti board, the rise in the price of gold was to come at a rather unfortunate time. The gold price rise and Ashantis' precarious situation was to result in a serious adverse effect in its stock price. This is because Ashanti did not have the liquidty to meet its margin calls and as a result sent a negative view about the firm amongst investors. The rally in gold resulted in a 50per-cent decline in Ashanti's' stock value. The stock price was to fall from $8.50 (a market capitalization of $890 million) to $4.62. The stock continued to plunge to a 12-month low of $3 on 6 October 1999 from an annual peak of $10.69 in January 1999. Ashanti at this stage had been completely wrong footed and was ripe for a take over. By far the largest quoted company in Ghana, Ashanti found itself in a financial debacle of enormous proportions after placing bets on the direction of gold prices. Ashanti had overstepped the delicate balance of using derivatives as a risk management tool and speculating with shareholders capital. The firm had hedged more than it was ever capable of producing for the duration the hedge deal.

Its problems where essentially due to its speculative hedging activity, which I am share holders where not aware of and the resulting cash flow issues. However since it had been completely wrong footed, it was liable for a take-over. John Hathaway of Tocqville Asset Management stated (in a report) that "as of June 30 Ashanti Goldfields was hedged 11 million ounces of production 50 percent of its reserves. According to Hathaway using "conservative assumption" the value of hedged book was $290 million. However, the asset would become worthless "if gold traded at $325; at $330, the company would begin to face margin calls". Hathaway wrote "The Ashanti hedgebook is a bet that the gold market would will remain quiescent and trouble free. Ashantis' sanguine view of the market is not unusual. Few in the industry are prepared to hope for a spike in the gold price, especially one which does not retrace".Well as events turned out Hathaway was not too far from the truth. As at 8 October 1999, the Ashanti hedgebook partly designed to protect profits resuting from a decline in the price of gold and partly as an alternative source of profits which I hasten to add is not the reason for hedging, had a negative value of $570 million at a gold price of $325 per ounce. With this negative value of $570m, Ashantis' bankers had the right to request cash deposits of $270 million as variation margin on the derivative contracts.

At this stage the question to ask is why was Ashanti so heavily exposed. Hedging is not a new financial phenomenon. It was used by the Egyptians before Christ to manage risk. Most commodity buyers and sellers use various forms of financial instruments as part of their financial strategy to protect or enhance their revenues. Generally Hedging is a means by which producers lock in to the current price of a commodity in respect to future production. Thus by selling forward producers can predetermine their revenue over a specific time period. This process of selling short enabled Ashanti to realise profits even when the price of gold was falling. Ashanti will have to hedge only a certain amount of its reserves since it will be able to physically deliver the gold when the hedging instrument matured. Thus although it will sell its gold at the prevailing market price, it would realise a profit on its hedging activity. The net effect will be that Ashanti would have realised the returns it had deemed acceptable as part of its financial strategy when it entered into the derivative contracts. Any increase or fall in the price of gold should under these circumstances have not been of concern to Ashanti since the net effect would be similar. However, Ashantis' hedging strategy was not designed on managing risk. It had crossed the fine line between using derivatives as a risk management tool to using it speculatively. Prior hedging activity had provided positive returns to the firm, and it begun to see these as an alternative source of its profits. Ashanti was taken positions in the gold derivative markets, which were much larger than actual production for the periods that these positions were open. As to whether it had systems in place which could capture and quantify these risk appropriately as well as the expertise to develops risk models which highlighted the firms worse case scenario is a question only Sam Jonah and Mark Keatly his then Chief Financial Officer can answer.

Several explanations have been put forward for this state of affairs. It is argued that Sam Jonah and Mark Keatly did not understand the nature of the derivative instruments they had entered into. This is an unlikely explanation because it was reported that Mr Keatly had boasted about having taught the investment bankers all they had to know about derivatives. For someone to make such a statement he must have known a fair bit about the instruments even if not their mechanics. Another explanation was that put forward by Mr Jonah himself that ". This has more to do with our address than our fundamentals, or the strength of our management". This excuse is not credible because Ashanti when agreeing and signing its derivative contracts would have agreed to the margin terms which were based on a credit assessment of the firm by its counterparts.

That Ashanti after its floatation has performed badly, could be easily explained as being due to the fall in the bullion price. However it has even under performed this benchmark. Ashanti after a disastrous management and financial strategy sought to rectify its performance by speculating in gold under the pretext of managing its risk. Mr Jonah had boasted that his firmed had earned more than $600 million dollars from hedging. Sam Jonah has not only let the shareholders of Ashanti down, but also the people of Ghana and Africa as a whole. He was entrusted with the management of the one of the few African companies listed globally, and he has not only underperformed the bullion price but almost sought to bring the company to its knees through rogue trading. Shareholders bought Ashantis' stock because they believed the company was prudent and financially sound. However as events have turned out its seems they would have been better of if they had invested their money in high risk gold futures and options. For the sake of Ashanti and to set precedence to weak ineffectual managers in Ghana and the rest of the emerging world Mr Sam Jonah and Mark Keatly must GO!!. Mark Keatly has already departed but now we await Sam Jonah to do the honourable thing. It is not too late.

Recent suggestions by Jonah that Ashantis stock is under performing because of the governments golden share are baseless and his attributing this to Ghana’s attractiveness to foreign investors shows how low this man can stoop to save his own damaged reputation. Investors where aware of the governments golden share when they bought the stock at over $25, and so was Lonmin when it acquired 32% of Ashanti. Furthermore I find it rather strange that the Ghana SFO, failed to bring charges against Sam Jonah since Ashantis speculative activity was not within the remit of the firm. If Tsatsu Tsikata is on trial today for financial impropriety, then so should Sam Jonah. They are both guilty of misallocating funds through speculative activity, Gold derivatives for Jonah and Crude Oil derivatives for Tsikata. Sam Jonah through Ashanti, introduced Tsatsu Tsikata to J Aron the commodities arm of Goldman Sachs.

For too long weak management in Ghana from the State to heads of Institutions have used external factors to cover their inefficiencies. In most circumstances the workers have been made to bare the brunt of the results of ineffective management.

The time has come for the people of Ghana to exercise their sovereign rights through their elected government. The government should not allow its desire to promote private business be abused by opportunist like Sam Jonah who seek to [our gold dust in its eyes.

Gold is our countries highest earner and we should be careful not to loose control of this asset. The Ghana government should seek to ensure it keeps a keen eye on the management of these firms. In short the government should not be passive in the event of such financial scandals. The recent example at Enron and the role of Ken Lay has laid bare the fact that corporate big wigs far all their schmoozing are dangerous and should be watched closely.

For in this game the Barbarians are at the gate. No one individual is bigger than Ashanti, and as a company and for the sake of shareholders and the people of Ghana, Ashanti deserves better.

Raymond Taylor , London UK.