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Currency Mining:
The Seven Deadly Sins: A Miner’s Perspective Introduction 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. Objective 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 Currency Mining: 1. Ignoring currency or starting with an exchange rate forecast 2. Seeing only dangers and missing opportunities 3. Focusing on exchange rates, not mining 4. "Monitoring carefully" 5. Failing to search for the word “if” 6. Leaving money in the bank’s pocket 7. 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 start: Where 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 Correct 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 following questions. 1. If the exchange rate improves, what should I do? 2. If it gets worse, what should I do? 3. 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 has opportunities. 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. Example (Self-diagnostic): You sell a tenement for A$10 million. Payment is in one year. Your profit on the sale is A$400,000. The American buyer offers US$10m, as the exchange rate is currently at AUD 1.0000 = USD 1.0000. This removes the American’s exchange rate risk, but leaves you with US Dollars, not Australian Dollars. Do you accept? a. Yes b. No 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. Remember: Price (metals) X Price (Exchange rate) = Revenue Sin Number 4: “Monitoring Carefully” This relates to benchmarking and is central to most sins. Take the Harbour Bridge Test  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. Do you: 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. Example: 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 says: “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 pocket 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
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 currency account 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 this). 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 products. 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. Summary Things the Board or CEO doesn’t want to hear … [1] "We’re in the business of mining, not foreign exchange” [See Sin No. 1] [2] "The Australian dollar is strengthening: this is dangerous" [See Sin No. 2] [3] "The Australian dollar is collapsing: this is dangerous" [See Sin No. 2] [4] “I leave currency management to the finance people” [See Sin No. 3] [5] "We’re okay as long as long as nothing major happens" [See Sin No. 4] [6] "Monitor carefully" [ See sin No. 4] [7] "Fortunately, all our contracts are in Australian Dollars" [See Sin No. 5] [8] "The bank loves me – I got another free ticket to their box at the football.” [See Sin No. 6] [9] "Our currency advisor is our bank dealer." [See Sin No. 7] [10] "The bank handles our foreign exchange risk." [See Sin No. 7] |
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