FYI | Feb 23 2011
– Producer's hedging their precious metals prices is making a return
– So far the come-back appears limited to by-product producers
– This favours gold over silver this year
Why Hedging Isn’t a Dirty Word for Precious Metals Anymore…
By Tony D’Altorio , Investment U Research Tuesday, February 22, 2011
For years, hedging was a dirty word among gold and silver miners. It meant they had to sell much of their future gold or silver production at low, fixed prices when prices were in the doldrums. And it led to losing fabulous opportunities at a fortune as gold and silver prices rose sharply. Naturally, stockholders didn’t take well to that news. They pressured the companies to spend billions over the last several years to buy back those hedges. And the way that idea caught on, some industry insiders thought hedging was gone for good. Yet in the past two months, at least five mining firms have executed silver hedges to protect against a drop in value. They did that either by selling future production or buying options against falling prices.
Deutsche Bank estimates the amount of silver hedged in the past two months exceeds 100 million ounces. That is several times the size of total outstanding hedges (20 million ounces) in late 2010 and equivalent to 15% of annual production. This could be a sign of a larger scale trend and a bearish future for precious metal prices. It could directly increase selling pressure, indicating a lack of insider confidence in the sustainability of current prices.
Closing the Global Hedge Book on Precious Metals
To no surprise, investment banks have led the hedging charge. They are actively advising their mining clients to begin looking for cover. They argue that a more positive economic outlook and rising interest rates will dampen precious metal demand . But they forget that the Federal Reserve’s plentiful printing is fostering inflation in the emerging world, thereby increasing demand in populous countries like China and India. From a larger perspective, a return to some hedging might just be a natural cycle shift. The number of outstanding gold and silver hedges – called the global hedge book – has declined for years as mining companies buy back unprofitable ones. That activity, known as “de-hedging,” has helped drive precious metals’ performance over the past decade. In effect, the buybacks have added to demand for gold and silver.
Last year though, de-hedging came to an end for all intents and purposes. AngloGold Ashanti ADR (NYSE: AU ) was the last major gold miner to close out its hedge book.
Good News for Precious Metals Investors
The good news for precious metals investors is that recent hedging activity has been limited in two important ways… First, it has been confined to the silver market. And second, only miners that produce silver as a byproduct have fallen back on the trick. Most in the industry don’t see it catching on for a while, at least not for miners who predominantly produce gold or silver. That includes: AngloGold Barrick Gold (NYSE: ABX ), Newmont Mining (NYSE: NEM ), Pan American Silver (Nasdaq: PAAS ), Fresnillo (PINK: FNLPF )
The reason is simple…
To Hedge or not to Hedge: Investment Bankers vs. Precious Metals Shareholders
Investment bankers can say what they want, but precious metals shareholders want nothing to do with hedging. Those investors have been burnt too many times in the past by their stocks underperforming gold and silver prices because of bad hedging. Instead, they want leveraged plays on price increases. If management locks them into fixed, low prices, shareholders could dump their holdings in droves. Knowing that, they’ll probably bow to investor wishes this year. Expect most hedging to be done by companies that mine precious metals as a byproduct of other metals. Still, their actions could put a cap on silver for 2011.
This type of hedging does have bearish implications for silver investors, since 70% of the metal is produced as a result of mining other base metals such as copper, nickel, lead and zinc. This means gold stands a good chance of surpassing silver in 2011. Investors should stick to gold equities if they want to add some shine to their portfolios.
Good investing,
Tony D’Altorio
Reprinted with permission of the publisher. The above story can be read on the website www.investmentU.com. The direct link is: http://www.investmentu.com/2011/February/precious-metals-hedging.html
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