The gold mining industry is increasing its net hedged position for the first time since 2011 after a plunge in gold prices worried creditors, but a return to selling forward masses of bullion is a distant prospect.
At its peak in 1999, the volume of the gold hedges - future output sold forward to guarantee revenue streams - reached more than 3,000 tonnes. By the end of last year, that outstanding hedge book had dwindled to just 78 tonnes.
Last week GFMS analysts at Thomson Reuters predicted a return to net hedging this year after a 9 tonne rise in outstanding hedges in the first quarter, as miners' hedging outweigh their de-hedging.
Russia's Polyus Goldrecently put in place the biggest hedge seen in the gold market in years. [ID:nL6N0PE1VA]
But while the idea of hedging a small amount of production for a limited period is gaining some support, the change in trend comes with stiff conditions.
"When companies do it, they have to do it for some pretty good reasons, and it has to be case-specific," Scott Winship, portfolio manager at Investec Asset Management, said.
"For, say, a single miner bringing a mine into production, which is typically a very high risk period of time for a company, it is prudent to hedge some production. But we're talking about 10 to 20 percent for a fairly short period of time."
Hedging is designed to guarantee revenue streams by protecting mining companies from falling prices. Some lenders require companies to provide a certain level of price protection before they agree to fund new projects.
The limitations of hedging were starkly illustrated in the last decade's gold price rally, however, with big miners such as Barrick Gold and AngloGold Ashanti spending billions of dollars to close hedges that were preventing them from capitalising on the bull run.
The rally ended dramatically last year with a 28 percent slide. In the current environment, smaller producers using short-term, flexible structures on individual projects can satisfy their creditors while not turning off their investors.
"Gold companies need to prove to investors that they can manage their balance sheets," Clive Burstow, investment manager at Baring Global Resources, said. "If used prudently and wisely, hedging is a very good tool for miners to use. Junior miners can use hedging when developing an individual mine, for instance."
MEANS TO AN END
That's not to say that the industry is embracing hedging wholeheartedly.
RandgoldChief Executive Mark Bristow said while he is happy to use small hedges as a means to, for example, secure cheaper financing, it's a measure that should be used sparingly.
"We have never been anti-hedging. We will hedge - but we hedge projects, capital, and we hedge end of mines for closures," he said. "So we will hedge, but right now hedging production for the sake of just trying to survive doesn't make sense at all to me.
"It's all about cost of capital. If we can secure financing at a better price, we put a hedge on."
For fund managers, a mining company hedging a larger proportion of production would undermine its appeal as an investment. Gold mining companies are often bought as a proxy for the underlying asset price.
"As investors, we don't want to invest in a processing mining company that has a very steady margin because it's hedged," Angelos Damaskos of Sector Investment Managers said.
"An investor in a gold miner is much more opportunistic and much more ambitious about the prospects for gold."
In the absence of immediate balance sheet pressures, a decision on whether to hedge is effectively taking that investment rationale out of the equation for investors who believe gold is likely to rise.
Last year's price crash bottomed out at $1,180 an ounce, and the metal is currently up 10 percent on this year, cheering some gold bulls who predict that instability in the global financial sector and buying by Asian consumers will push prices higher.
Others say, however, that gold prices could have much further to fall as U.S. monetary policy normalises and interest rates rise across the globe, increasing the opportunity cost of holding non-yielding bullion.
Faced with this uncertainty, neither mining companies nor investors want to take the risk of missing out on what could be a market with plenty of upside.
"The nature of these markets is that when prices are high, people are even more bullish and expect the price to go to $3,000," Investec's Winship said.
"It's a very difficult position to take for a company, and generally I think people are going to steer fairly clear."
At its peak in 1999, the volume of the gold hedges - future output sold forward to guarantee revenue streams - reached more than 3,000 tonnes. By the end of last year, that outstanding hedge book had dwindled to just 78 tonnes.
Last week GFMS analysts at Thomson Reuters predicted a return to net hedging this year after a 9 tonne rise in outstanding hedges in the first quarter, as miners' hedging outweigh their de-hedging.
Russia's Polyus Gold
But while the idea of hedging a small amount of production for a limited period is gaining some support, the change in trend comes with stiff conditions.
"When companies do it, they have to do it for some pretty good reasons, and it has to be case-specific," Scott Winship, portfolio manager at Investec Asset Management, said.
"For, say, a single miner bringing a mine into production, which is typically a very high risk period of time for a company, it is prudent to hedge some production. But we're talking about 10 to 20 percent for a fairly short period of time."
Hedging is designed to guarantee revenue streams by protecting mining companies from falling prices. Some lenders require companies to provide a certain level of price protection before they agree to fund new projects.
The limitations of hedging were starkly illustrated in the last decade's gold price rally, however, with big miners such as Barrick Gold and AngloGold Ashanti spending billions of dollars to close hedges that were preventing them from capitalising on the bull run.
The rally ended dramatically last year with a 28 percent slide. In the current environment, smaller producers using short-term, flexible structures on individual projects can satisfy their creditors while not turning off their investors.
"Gold companies need to prove to investors that they can manage their balance sheets," Clive Burstow, investment manager at Baring Global Resources, said. "If used prudently and wisely, hedging is a very good tool for miners to use. Junior miners can use hedging when developing an individual mine, for instance."
MEANS TO AN END
That's not to say that the industry is embracing hedging wholeheartedly.
Randgold
"We have never been anti-hedging. We will hedge - but we hedge projects, capital, and we hedge end of mines for closures," he said. "So we will hedge, but right now hedging production for the sake of just trying to survive doesn't make sense at all to me.
"It's all about cost of capital. If we can secure financing at a better price, we put a hedge on."
For fund managers, a mining company hedging a larger proportion of production would undermine its appeal as an investment. Gold mining companies are often bought as a proxy for the underlying asset price.
"As investors, we don't want to invest in a processing mining company that has a very steady margin because it's hedged," Angelos Damaskos of Sector Investment Managers said.
"An investor in a gold miner is much more opportunistic and much more ambitious about the prospects for gold."
In the absence of immediate balance sheet pressures, a decision on whether to hedge is effectively taking that investment rationale out of the equation for investors who believe gold is likely to rise.
Last year's price crash bottomed out at $1,180 an ounce, and the metal is currently up 10 percent on this year, cheering some gold bulls who predict that instability in the global financial sector and buying by Asian consumers will push prices higher.
Others say, however, that gold prices could have much further to fall as U.S. monetary policy normalises and interest rates rise across the globe, increasing the opportunity cost of holding non-yielding bullion.
Faced with this uncertainty, neither mining companies nor investors want to take the risk of missing out on what could be a market with plenty of upside.
"The nature of these markets is that when prices are high, people are even more bullish and expect the price to go to $3,000," Investec's Winship said.
"It's a very difficult position to take for a company, and generally I think people are going to steer fairly clear."
