Commodities | Jun 02 2006
By Greg Peel
[For a better understanding of gold hedging may I recommend Gold Hedging – How and Why, Sell&Buyology, April 7, 2006]
In its latest Global Hedge Book Analysis, leading gold researcher GFMS notes the reduction in global gold hedge books in the March quarter was the greatest since late 2002. 4.6Moz was removed from outstanding contracts, leaving the total global hedge book at the end of March at 50.3Moz.
4.4Moz of the 4.6Moz reduction was accounted for in the forward contract book. 80% of this reduction was due to Barrick Gold’s extensive restructuring undertaken after its acquisition of Placer Dome. Restructuring can take many forms, either by rolling forward sales out to later date, or settling ahead of maturity, or simply not re-establishing matured hedge contacts.
The remainder of the hedge reduction was accounted for in non-vanilla option positions which fell in volume by 85%. Non-vanilla options are complex derivative trades undertaken with a single counterparty that are now shunned to a great extent by the market due to their propensity to turn gold hedgers into gold punters. The more clear-cut vanilla options positions actually rose 2%.
The reality of a reduction in gold hedging is that producers are now more free to sell gold at the prevailing spot price and not at a lesser predetermined price. While this might sound encouraging to gold producer shareholders, the other reality is that it is virtually impossible to say for certain that offsets aren’t adversely accounted for elsewhere, such as in currencies and bank loans, when hedge positions are unwound.
The only certainty is that if the gold price goes up it is better to be unhedged, and if it goes down it is better to be hedged. Given no one can say for certain which way the gold price will go, gold hedging represents risk management.
The gold price of US$582/oz at the end of March was used to mark hedge positions to market. This represented a US$69/oz increase on the previous quarter or a 37% reduction in hedge book value – a loss of US$10.6 billion.
On the other side of the ledger producers’ realised average gold price rose US$75/oz to US$533/oz, outperforming the spot price increase. Swings and roundabouts.
GFMS believes hedge unwinding had some positive influence on the gold price during the quarter, but any effect would have been swamped by the inflow from investment funds. Central Bank selling also reduced over the period, falling 50% year-on-year. Most of the reduction was linked to Central Bank Gold Agreement between European banks.
On the demand side GFMS noted a collapse in bullion imports for jewellery production, particularly from India and Turkey where gold is normally popular in the marriage season. Global production registered a modest increase due to a handful of recent start-ups.
What to read into gold de-hedging? It is almost impossible to say. What may look beneficial may yet be merely delaying hedge obligations or taking a loss elsewhere. If de-hedging occurs simply as a result of not renewing forward contracts as they roll off then yes, producers stand to reap more benefit from a gold price rally from here.