Commodities | Aug 22 2007
By Greg Peel
A wave of hedge book buybacks hit the gold market in the second quarter of 2007, according to the latest Societe Generale/Gold Fields Mining Services report. This led to a provisional 5.2 million ounces (161t) reduction in the global hedge book. After two quarters of active dehedging, the total global hedge position now stands at 34.2 million ounces (1064t).
Gold dehedging has become popular amongst gold miners ever since the gold price began to run up from its lows in 2001. The pace of dehedging has accelerated in recent quarters due to strong expectations for a higher gold price.
In its simplest form, gold miners can use gold hedging to provide (a) protection against a move down in the gold price or (b) funding for mine development/expansion. As a going concern, a gold mine would be in jeopardy if the gold price fell below the cost per ounce of gold retrieval. To offset losses from such an occurrence, gold miners can sell their production forward and thus lock in a price for gold yet to be produced. They then receive money now for gold they must deliver in the future. Apart from locking in an achieved price, the miner can use that money to cover costs and invest in further development. A start-up miner can forward sell some of its expected production simply to raise funds to finance production in the first place.
More complex forms of hedging involve derivative instruments.
The problem with hedging is that if the gold price runs up, the hedged gold miner cannot participate in those spoils, having already sold production forward. This problem usually means abandonment by existing and potential shareholders, given loss of potential profits. But as forward sales tend to be made over programs running out to several years, a miner is often stuck with its hedge position.
A miner can dehedge by not rolling over forward sales that reach delivery, or by simply biting the bullet and buying back its hedge book from the contract holders and copping it sweet on the difference in price. While this can be costly, it removes the dampener on upside profit potential and is invariably popular with investors. Since gold has been running hard from the US$200s to the US$600s many a bullet has been bitten.
Dehedging in a bullish market also provides a boost to gold price bullishness, as miners are not selling gold they haven’t yet produced into the market.
Gold dehedging hit a record in the second quarter according to GFMS. The bulk of the dehedging was a result of hedge book buybacks from Newmont and Lihir (LGL). AngloGold Ashanti, Barrick and Buenaventura also made significant contributions from hedge book reductions. In 2006, gold dehedging was dominated by Barrick as it bought back the hedge book inherited from its Placer Dome acquisition.
There were still meaningful, if not dominant, hedges put in place in the second quarter by various miners.
GFMS makes an “interesting observation” that while dehedging in 2007 has reached record levels, the numbers still pale by comparison to the total of hedges put on during gold’s steady fall in the late nineties.
On the production front, GFMS reports provisional assessments suggest second quarter production rose moderately year on year. The biggest contributor was Freeport McMoRan’s Grasberg mine in Indonesia. By contrast, the world’s biggest producers such as Barrick and Newmont have seen their production decline. South African miners AngloGold Ashanti and Gold Fields have also reported declines.
All up, the gold price did nothing spectacular in the second quarter, despite record dehedging. This is because the benefits were offset by a barrage of central bank gold sales coming the other way. GFMS estimates 148t of gold were sold by central banks in the second quarter – 26% more than the previous second quarter and 38% more than the first quarter. Spain was the biggest seller, offloading 70t as it battled with a rising national debt. France and Switzerland were also significant sellers, and Switzerland has indicated its intention to sell more gold over time.
The Washington Agreement countries were the only central bank sellers of gold in the second quarter, unless you count the Philippines, which unleashed one tonne. Purchases were insignificant, but came from Russia, Kazakhstan and Qatar.
Most gold analysts expect central bank selling to decline in the third quarter as we approach the end of the Washington Agreement quota year in September. But then again, most analysts were not expecting the extent of second quarter sales. More reliable is GFMS’s conclusion that producer dehedging will drop off in the third quarter. Most of the big books have now been bought back.