In 2009 news that Barrick Gold was going to close its hedge book to capitalize on what they projected were going to be higher gold prices. It turned out to be a very bullish indicator that I wrote about here on this blog (and other blogs picked up on it as well). It was at a time when even I was projecting higher gold prices. Let’s first review their 2009 decision (source Reuters)
Barrick Gold Corp (ABX.TO) said on Tuesday it had completely eliminated its fixed-price hedge book, allowing the company to take full advantage of rising gold prices and sparking a 7.6 percent rise in its shares.
Perhaps appropriately, the announcement came on a day the price of gold hit $1,200 for the first time, as the hedges -- which totaled 3 million ounces before Barrick began buying them back in September -- had become a symbol of the company's inability to benefit from a favorable gold environment.
"As of today, we are a fully unhedged gold producer," Barrick Chief Executive Aaron Regent said at an investment conference in New York.
The elimination of hedges comes earlier than the company had planned. Barrick said in September that it would get rid of all its hedges within 12 months, but sped up the pace due to the continued rise in gold prices.
"Our positive view on the gold price led us to accelerate the elimination of these contracts ahead of the schedule we had established," Regent said in a statement.
Fast forward to today with the price of gold significantly off its 2011 high. Kitco today is reporting that some miners might start re-evaluating this strategy and might turn to hedging again. The decision to close their hedge books was perceived as bullish for the price of gold going forward. Should miners start to open hedge books again I would perceive this as bearish for the price of the yellow metal going forward. Only time will tell but it is an important factor that we should keep our eyes on.
From Kitco News:
FOCUS: Some Gold Miners May Rethink Hedging As Costs Rise, Prices Fall
Rising costs and the drop in gold prices last month might put some gold miners in the uncomfortable position of having to consider hedging production.
Production hedging is done to guard against downside price movements and is common in many commodity-based industries. In agriculture, for instance, farmers and other producers will hedge future output to help make at least some of their production price neutral. This can be done by selling futures contracts or through more sophisticated options or other forward contracts. The idea is that if prices go up, the commodity on hand offsets losses from the hedge, while if commodity prices fall, the hedge makes up for the discount the producer takes on the physical commodity.
In metals, however, production hedging is often frowned upon. In the 1990s, hedging was common place when prices were much lower and gold prices were in a bear market. It was big news several years ago when major producers like Barrick announced in 2009 that it was closing its hedge book.
Erica Rannestad, commodity analyst at CPM Group, explained why production hedging in metals can be loathed by corporate shareholders and others: “Some companies don’t want to hedge their primary metal; they feel that hedging represents a lack of belief (in production/prices).”
For some miners, that might be a luxury they cannot afford. Miners have struggled lately with rising operational costs and shareholders are demanding miners hold the line on costs. When gold prices were near their all-time nominal high of $1,925 an ounce, shareholders turned a blind eye to costs, but when the price of gold was stagnating in the upper $1,500 to the lower $1,600s an ounce, reining in costs became important. Then came the mid-April price break.
When prices dipped to the $1,320s area, it started to come close the marginal cost of production plus sustaining capital expenditures, called “all-in costs.” Estimates of those costs range between $1,200 and $1,300, analysts said.
In fairness however, we should point out that this isn’t a done deal. However, the fact that it is even being discussed may give us some clues as to where the major miners think the price of the yellow metal may be heading.
Not everyone believes that miners will not turn to hedging. Robin Bhar, metals analyst at Societe Generale, said production hedging is going to happen at some point. “We think they have no choice. They can cut expenses, but they might not have a choice but to hedge. Equity holders like the upside they get from the gold price, but at the same time they don’t want the company to be out of business,” Bhar said.
Societe Generale’s commodities team is bearish on the outlook for gold prices and part of the reason is the expectation that producer hedging will put a cap on prices. “It’s one of the reasons why any rallies won’t be sustained. Companies will use the rally to hedge, especially if prices get back to $1,500-$1,550, they’ll use it as an opportunity,” Bhar said.
There is another aspect of hedging that is different now than it was in the 1990s and that’s interest rates are near zero now because of quantitative easing by central banks. That could limit interest in hedging.
“Unlike in previous cycles, any possible producer hedging is unlikely to serve as damper on gold, as it will be very difficult to use traditional forward sales hedging given the credit environment in the commercial banking sector,” said Bart Melek, vice president and director head of commodity strategy, rates and foreign exchange research at TD Securities.