LAWRIE WILLIAMS: Is gold hedging going mainstream again?
In theory, gold hedging (effectively the forward sale of some of a company’s prospective gold production) increases available physical gold supply and as such should depress the gold price with the ‘borrowed’ gold being sold into the spot market. In practice it seems almost always to have been a case that although this theory should be correct, the correlation between gold hedging and the gold price may not be quite so simple – in part because so often mining companies get their timings so completely wrong. The pattern back in the early part of this Century was that many of the major producers were still hedging their production forwards into a rising gold price, thus adversely affecting their earnings through not benefiting from the increasing prices for a part of their production. By the time they had realised this and entered into significant de-hedging activity the gold price was peaking and much of the big de-hedging activity took place into a falling gold price scenario – again defeating the point in terms of protection of earnings. So are hedging and de-hedging actually contra-indicators? Certainly not in theory, but seemingly actually so in practice.
I recall attending a luncheon meeting back in early 2012 I think, when the guest speaker was Graham Birch, former head of the then hugely successful Blackrock gold fund. His timing was impeccable. He left the London financial sector to go dairy farming in 2010 ahead of gold peaking. At Blackrock he had been one of the strongest proponents of the move to dehedge in recognition of the impact of earnings of the gold hedgebooks being held in what was then the big gold price rise – which continued for another year after he left the sector. But at the luncheon at which he was the guest speaker, despite by then being a dairy farmer, he suggested that mining companies should be returning to hedge some of their forward gold output. His timing was again impeccable – but did the mining companies take up this advice – No! Over the following four years the gold price slipped from the then $1,700s back to $1,100 or lower. But the mining companies were still preaching dehedging – almost with evangelical intensity.
Now if Birch had remained running the Blackrock gold fund his views might have had some impact and some, who might have then followed his advice at that time, might have been spared some of the adverse impacts of the falling gold price over those years. But this did not happen.
Now we are beginning to see net gold hedging activity creeping back with some very big miners starting to lock in what they see as high – perhaps peak – gold prices again. Could they be as equally wrong in so doing as their predecessor managements? It does seem though that there is a second angle to this activity – that of local currency parity with the US dollar – with a dominance in new hedging in countries like Australia, South Africa and Russia where their currencies had been in sharp decline against their US counterparts and, in terms of their domestic currencies in which most of their costs are incurred, gold has been riding at or near all-time highs.
However the miners are a little wiser nowadays – or their financial advisers are – in that most of this hedging is for relatively short periods so they are not locked into these prices almost ad infinitum, which was the case back when gold hedging was at its previous peak. So, if circumstances change, and gold goes on a tear, they will probably not be in the position where enormous sums need to be spent to unwind these hedges to maintain the benefits of rising gold prices.
A case in point is big marginal gold producer, Harmony Gold (HMY), one of the best gold sector performers in terms of its stock price so far this year. All of its gold output at the moment is in South Africa where the local currency, the rand, has seen an enormous fall against the US dollar in which the gold miners receive their revenues. Harmony has a potential mega-project in the pipeline in Golpu in Papua New Guinea, in conjunction with Australian gold major, Newcrest and is thus keen to lock in profits by hedging some 20% of its gold production forward for two years at a price of Rand682,000/kg (equivalent to around a very large $1,480/ounce at current exchange rates). Harmony’s share in Golpu is expected to cost well in excess of $2 billion so perhaps the logic in the Harmony move is positive. 20% of Harmony’s gold production over the next two years will amount to around 430,000 ounces plus (over 13 tonnes) so is a considerable amount of gold. Interestingly Newcrest too has been hedging production forwards and was the biggest contributor to the global gold hedging total in Q1 this year. It too is presumably looking to build up cash reserves ahead of its share of the Golpu development.
Incidentally another gold major, Polyus Gold in Russia, a nation which has also seen a big fall in its currency parity vis-a-vis the US dollar, was the second largest hedger in Q1.
So Harmony is not the only major gold miner out there looking at implementing a hedging strategy this year. In its recent hedging analysis GFMS noted that it expected to see growth in hedging activity through the remainder of the year. (See: Gold hedging increased in Q1. Positive or negative?). It put the overall growth in the global gold hedge book during the first quarter of 2016 at 1.62 million ounces (50 tonnes) with the global hedge book total standing at a delta-adjusted 8.69 million ounces (270 tonnes) at the end of the quarter.
With such heavy hitters among the world’s top 20 gold producers as Newcrest (world’s No. 6 producer), Polyus Gold (world No. 9) and Harmony (world No. 18), it does look as though gold hedging may be becoming mainstream again. Will other top miners follow suit – and if so will it be yet another contra indicator suggesting big gold price rises ahead as in the past when many of the gold majors got their timings totally wrong – or have they learnt their lessons this time?
20 Jul 2016 | Categories: Gold