State-owned enterprises

Chalco also a gold miner? Aluminium giant unveils gold leasing contracts with Bank of Communications

Chalco to enter into gold leasing and hedging agreements with Beijing bank as it seeks new sources of income. Analysts say they didn’t know Chalco had gold production

PUBLISHED : Sunday, 19 June, 2016, 5:39pm
UPDATED : Sunday, 19 June, 2016, 5:39pm

A surprise announcement by Aluminum Corp of China to enter into 3 billion yuan (HK$3.53 billion) of gold leasing contracts highlights the state-backed firm’s need to reap profits or cost savings from non-core operations as it struggles in the overcapacity-troubled aluminium industry, analysts say.

The gold leasing deal followed several asset disposals by the nation’s second-largest smelter of the lightweight industrial metal to offset losses.

“It is very difficult for Chalco to make a profit from its core aluminium operations [given its high production costs], so it needs to think of ways to generate profits or savings from non-operating activities, and gold leasing may be one,” said Huarong Securities’ Beijing-based analyst Zhang Feihong.

Although Chalco reported a net profit of 206 million yuan last year, against a net loss of 16.2 billion yuan in 2014, the profit was “heavily inflated by after-tax extraordinary gains of 6.64 billion yuan”, according to a JP Morgan research report.

The gains included a 1.77 billion yuan government grant and one-off gains from the sale of two business units and other assets, the report said.

Chalco posted a net loss of 608.3 million yuan for the first quarter of this year, as aluminium prices remained low despite a moderate price recovery.

Chalco said recently it struck various gold leasing and hedging agreements with the Beijing branch of Bank of Communications, under which it would be provided with “standard gold in Au99.99 fineness” which is traded on the Shanghai Gold Exchange.

The market value of the “leased” gold is 3 billion yuan, based on an undisclosed settlement price agreed between the two parties.

Instead of requiring Chalco to pay a security deposit, Bocom will freeze 3.3 billion yuan of working capital credit facility it has made available to Chalco.

Chalco said it would pay the bank a leasing fee, certain charges for futures contracts and other transaction expenses, the total of which would not exceed the benchmark interest rate for one-year loans as set by the People’s Bank of China.

The gold will be leased for 12 months, and the bank will be “entrusted” to sell it to raise funds as additional working capital for Chalco.

On expiry of the agreement, the gold will be bought back at the same price through a forward contract and Chalco will return the same quantity and type of gold to the bank.

Analysts said they were surprised since Chalco was not known to have any gold production.

Gold leasing is generally used by producers and processors to hedge price risk by locking in selling or buying prices, and as a lower cost way of financing operations compared to borrowing.

CLSA head of resources research Andrew Driscoll likened gold leasing to borrowing dollars, but that it was gold which was being lent and borrowed.

In typical gold leasing business overseas, the leasing bank acts as an intermediary by borrowing gold from the central bank and constructing the forward price, he said.

“Chalco’s foray into the gold leasing business is surprising,” Driscoll said. “It appears to be trying to broaden its financing channels.”

Chalco declined to comment on whether it plans to expand the scale of its gold leasing operation and the cost savings it can reap from such deals.

In the mainland, gold leasing had been linked by media reports to speculative activities and fraud.

In 2014, the National Audit Office uncovered 94.4 billion yuan of loans backed by falsified gold transactions.

Gold leasing is a lucrative business. A report by the audit office said 25 of the nation’s bullion processors made a combined profit of more than 900 million yuan from leased gold-backed loans.

According to Koos Jansen, a Singapore-based precious metals trader and research provider, the mainland’s estimated leased gold volume at any one time last year would not exceed “a few hundred tonnes”, even though about 1,600 tonnes of lease deals of different durations were recorded in 2014.

The mainland’s gold purchases totalled 986 tonnes last year.

It had 1,808 tonnes of gold reserve at the end of April, according to the central bank.

Research by consultancy Precious Metals Insights found some firms other than genuine gold businesses borrowed and sold gold to obtain funding and hedge their positions, according to Jansen.

Chalco said since it would buy and sell gold to Bocom at the same price, its gold leasing transactions were free from the risk of price fluctuations.

Bocom’s website marketed gold leasing as a tool that can help its corporate clients lower operating costs, relieve debt pressure and hedge asset price risks.

In its marketing materials, Bank of Shanghai says its gold leasing corporate clients are prohibited from using funds raised from the sale of leased gold to invest in stocks or equity in unlisted firms.