The Seven Deadly Sins: A Miner’s Perspective
Seven of the most common
errors made by mining companies in foreign exchange exposure management
are outlined below.
Most also apply to
interest rate risk and to commodity risk.
This article is designed
to help a mining company avoid committing the seven deadly sins and
seven suggestions to help increase profits by at least AUD 10,000 per
USD 1 million of exposures every year.
The Seven Deadly Sins of
Ignoring currency or starting with an exchange rate forecast
Seeing only dangers and missing opportunities
Focusing on exchange rates, not mining
Failing to search for the word “if”
Leaving money in the bank’s pocket
Using banks for exposure management advice
Sin Number 1:
Ignoring currency or starting with a rate forecast
Beware any miner who
says: "We’re in the business of mining, not foreign exchange”.
Every miner is exposed
to foreign exchange – and even a dead dog can float with the current.
Since you don’t actually
have the luxury of assuming you aren’t in the mining game, possibly
there is an assumption that the currency won’t move (that would be a
first) or will move in your favour.
So to an alternative
do you expect the Australian Dollar to be in six months?
a. about the
same or higher
b. about the
same or lower
c. don’t know
answer: Don’t know.
No one can consistently
forecast exchange rates. Instead, every mining company should be able
to provide its Board of Directors with the written answers to the
If the exchange rate improves, what should I do?
If it gets worse, what should I do?
If it stays put, what are the implications for my business?
If you are a Board
member, ask for theses answers – the resulting next few minutes will
teach you a great deal about your currency exposure management.
Sin Number 2: Seeing
only dangers, not opportunities
The Chinese put it best
with their depiction of the word "Crisis":
The first two symbols
stand for "Danger" and the second two for "Opportunity". Together they
make the word "Crisis".
The Australian dollar is
currently seen to be in crisis but while this may have dangers, it also
The current edition of
the Australian Journal
of Mining has 67 pages which mention foreign exchange. Not
a single page addresses what to do about it.
You sell a tenement for
A$10 million. Payment is in one year. Your profit on the sale is
American buyer offers US$10m, as the exchange rate is currently at AUD
1.0000 = USD 1.0000.
removes the American’s exchange rate risk, but leaves you with US
Dollars, not Australian Dollars. Do you accept?
Correct answer: Yes. In May 2012 you
could sell the USD 10 M one
year outright (to May 2013) for A$10,341,200 – an 85% increase in your
profit from $400,000 to $741,000
Sin Number 3: Focusing
on exchange rates, not mining
Every miner has both a
Profit & Loss account and a Balance
Sheet, which means that if the exchange rate goes UP:
You potentially benefit on one side of
the P&L and one side of the Balance Sheet.
If the exchange rate goes DOWN:
You potentially benefit on the other
side of the P&L and the other side of the Balance Sheet.
Plus you need to control
risks on the downside. Prices of metals and
exchange rates are both volatile and both need managing.
(metals) X Price
(Exchange rate) =
4: “Monitoring Carefully”
This relates to
benchmarking and is central to most sins.
Take the Harbour Bridge
You are going home after a hard day in the office.
As you get half way across the Harbour Bridge, the radio announces that
the Australian Dollar has just fallen by 50% in five minutes.
a. Immediately drive off the side of the Bridge?
b. Do a 180 degree turn and head back to the office?
c. Drive happily home?
Correct answer: (c)
You should know what to do when it happens – you’ll just not know when
“it” will occur.
There will be opportunities to take as well as risks to manage – this
is no time to “monitor carefully”.
This is an important point and is worth emphasizing.
If no explicit benchmark is set, there is an automatic default to a de
facto benchmark of "Monitor Carefully", or more exactly, "Do nothing."
Reports and forecasts will be profuse but directionless.
If you are a Board member, try out the Harbour Bridge Test on your
executive team – all of them; it’s relevant to everyone from the
Procurements Manager to the Treasurer.
Sin Number 5: Failing to search for the word “if”
All financial transactions can be replicated in commercial contracts.
Check for embedded options.
About 20% of companies use financial hedges and about 70% are exposed
to exactly the same factors embedded in export contracts, equipment
contracts and financing arrangements.
You intend to sign a contract to borrow USD 100 million for two years
but first check for the word “if”. You find that there is a clause that
“If, on the annual reset of rates, you want to swap to Australian
Dollars, you may do so at today’s spot rate if you wish to do so.”
This is an embedded option. In May 2012 it would cost about 3.6 % to
purchase such an option in the financial markets - or in this case,
since $100 Million is the size of the loan, around A$3,600,000.
If you don’t want or need this option, it can be on-sold.
You should receive around A$3.6 million cash up-front.
Worth checking. Or worth inserting in the loan contract.
Sin Number 6: Leaving money in the bank’s
Often miners are too busy to check on bank fees or FX rates.
Yet this is where banks make the majority of their revenue.
What have you reviewed recently? Below is a simple check list and a
list of warning signs that you are probably paying too much or
receiving too little
Bank Tender Check List
1. FX margins|| || || |
2. EFT costs|| || || |
3. Merchant fees|| || || |
4. Standby fees|| || || |
5. Credit Card fees || || || |
6. Vehicle loans/leases|| || || |
7. Overdraft fees|| || || |
8. Bank Bills vs. Deposits|| || || |
9. International fees|| || || |
10. Investment returns|| || || |
Seven warning signs
1. You use retail rates or “carded” rates
for any currency sales or purchases.
2. You don’t have your own offshore
3. You don’t tender your bank business
every three years or so.
4. You don’t get at least two quotes on
all treasury pricing over $10,000
5. You rely on a single bank
6. You use banks’ forecasting currencies
as budget or planning rates
7. You don’t get pricing clauses in
contracts valued (and your lawyer isn’t likely to be the one to do
Sin Number 7: Using bankers for exposure management advice
Three things worth noting:
1. Banks provide currency forecasts, but don’t use them.
Banks provide forecasts but don’t use them themselves – they are there
to encourage activity on your part.
The bank makes its money from the fees and margins, not taking
positions or speculating.
Their aim is to encourage you to use their products.
2. The only thing in common between a bank treasury and a mining
company treasury is probably the word “treasury”
Banks don’t start with an underlying exposure (see Sin No 1), nor do
they care about absolute currency levels – only margins (again, see sin
No 1). They are like any other shop in the arcade – they just retail
3. Banks aren’t miners.
Banks don’t take into account interactions between metal or ore prices
and currencies, or competitors’ behaviour or a myriad of other issues
relating to your operations. Often when you take these into
consideration your actual exposure is very different from the one the
banks think they are advising you to manage.
Things the Board or CEO doesn’t want to hear …
 "We’re in the business of mining, not
foreign exchange” [See Sin No. 1]
 "The Australian dollar is
strengthening: this is dangerous" [See Sin No. 2]
 "The Australian dollar is collapsing:
this is dangerous" [See Sin No. 2]
 “I leave currency management to the
finance people” [See Sin No. 3]
 "We’re okay as long as long as
nothing major happens" [See Sin No. 4]
carefully" [ See
sin No. 4]
 "Fortunately, all our contracts are
in Australian Dollars" [See Sin No. 5]
 "The bank loves me – I got another
free ticket to their box at the
football.” [See Sin
 "Our currency advisor is our bank
dealer." [See Sin
 "The bank handles our foreign
[See Sin No. 7]