Recent Gold Hedging Activity – a Warning Sign?
by Andrey Dashkov: A
Comeback for Gold-Backed Money?
In the first
quarter of 2011 (Q111), net gold hedging was reported by GFMS and
Société Générale. A gold mining company
may hedge its production on expectations of falling gold prices
in order to lock in high prices and possibly avoid losses. As gold
hits one nominal high after another, is such behavior a sign that
the bull market in gold is over?
To answer that
question, we had a look into Bolidens (T.BLS) latest interim
report. The GFMS study mentions that in Q111, Boliden was one of
the most active hedgers; it was accountable for 58% of gross hedging
activity during that period. Lets have a closer look at the
not a pure gold mining company. Gold is metal number three in Bolidens
portfolio, after copper and zinc. In the second quarter of 2011,
Boliden produced 158.5 million pounds of zinc and 45.2 million pounds
of copper in concentrates. Gold production in Q211 amounted only
to 35,062 ounces; silver, 1.9 million ounces. Boliden is a regular
Under the current
gold price environment, in the beginning of 2011 Boliden decided
to increase its gold production. It plans to accomplish this by
expanding operations at its Garpenberg zinc-copper-lead-gold-silver
mine and by starting up a new mine, Kankberg, which would produce
tellurium and gold. Both are located in Sweden.
hedging to insure its planned US$614 million (SEK3.9-billion) investment
into Garpenberg and US$75 million (SEK475 million) investment into
Kankberg. At Kankberg, it hedged all future tellurium production
and 80 percent of the gold output. The company wants to leverage
on the current high gold and tellurium prices to make sure Kankberg
operations remain profitable.
case is quite understandable. Hedging has been the companys
policy for quite a long time, and the need to insure two large new
production initiatives resulted in an unusual amount of new contracts.
seems to continue committing a significant portion of its future
sales in the form of forward contracts, about 60% of all deals at
the end of the first quarter make use of a different vehicle: collar
strategy provides the seller with a balance of limited downside
and more flexibility on the upside. The strategy in essence provides
a trader (a mining company, in our case) with a price corridor for
the contracts to fluctuate within. This is more flexible than setting
up a fixed forward price.
It is quite
interesting to see what the current price corridor for future gold
sales looks like, judging by the option positions held by gold hedgers.
Have a look at the following table:
|Minera Frisco, S.A.B. de C.V.
|Industrias Peñoles, S.A.B. de C.V.
|Golden Star Resources
|Coeur d’Alene Mines
seem quite familiar. The floors remind one of some of
the more conservative gold prices used in the current economic assessments
of gold projects: US$940.35 is close to what Exeter Mines (T.XRC)
used as the lowest gold price in its prefeasibility study on the
companys monster Caspiche deposit (US$1,000). The highest
ceiling, US$2,622, is higher than most of the best-case
mine scenarios, but is understandable as a gold price projection
based on how the metal has been performing so far in 2011. In short,
these numbers do not seem to reveal anything that we dont
the timing, however, is quite interesting.
Timing is an
important parameter in option pricing. As it turns out, on average
the hedgers contracts span over quite a short-term period.
Quoting the GFMS report:
industry as a whole appears to be less vehemently opposed to hedging
than was the case a couple of years ago, we note that most hedging
is still being undertaken over a short to medium time frame: little
hedge cover extends beyond 2013.
are outliers, however; and Boliden is one of them.
It is interesting
to note that around half of [Bolidens] contracts are scheduled
for delivery between 2014-2017; the longest dated contracts seen
for quite some time, put in place to secure the long term viability
of the Garpenberg expansion.
As we see,
the reasons behind the increase in hedging are understandable. There
are no signs of a tectonic shift in producer attitudes towards gold.
The most cautious ones take advantage of the metals price
increase, but their actions are largely company- and even project-specific.
Hedging can be a good way to increase investor confidence in a mining
project, to insure their investments, or to secure a bank loan.
We do not see that positive net hedging in the first quarter is
alarming the economic problems bubbling to the surface now
should provide a lot of reasons for the gold price to continue rising
for quite some time.
of the global hedge book is comprised of recent contracts, the report
says. They were entered into when gold hit nominal highs and some
of the mining companies started acting protective of their future
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Dashkov is a research analyst for Casey
© 2011 Casey