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FOCUS: Some Gold Miners May Rethink Hedging As Costs Rise, Prices Fall

By Debbie Carlson Kitco News
Wednesday May 1st, 2013 10:44 AM

(Kitco News) - Rising costs and the drop in gold prices last month might put some gold miners in the uncomfortable position of having to consider hedging production.

When gold prices fell to near $1,320 an ounce in mid-April, it came close to the cost-of-production levels for some gold producers and sparked some brief discussion about the possibility of a return to production hedging. Since then prices have rebounded, but the idea about hedging hasn’t completely gone away. If prices can remain around current levels, which are around $1,450 as of Wednesday, then several industry watchers said miners can avoid hedging, although that view wasn’t universal.

Production hedging is done to guard against downside price movements and is common in many commodity-based industries. In agriculture, for instance, farmers and other producers will hedge future output to help make at least some of their production price neutral. This can be done by selling futures contracts or through more sophisticated options or other forward contracts. The idea is that if prices go up, the commodity on hand offsets losses from the hedge, while if commodity prices fall, the hedge makes up for the discount the producer takes on the physical commodity.

In metals, however, production hedging is often frowned upon. In the 1990s, hedging was common place when prices were much lower and gold prices were in a bear market. It was big news several years ago when major producers like Barrick announced in 2009 that it was closing its hedge book.

Erica Rannestad, commodity analyst at CPM Group, explained why production hedging in metals can be loathed by corporate shareholders and others: “Some companies don’t want to hedge their primary metal; they feel that hedging represents a lack of belief (in production/prices).”

For some miners, that might be a luxury they cannot afford. Miners have struggled lately with rising operational costs and shareholders are demanding miners hold the line on costs. When gold prices were near their all-time nominal high of $1,925 an ounce, shareholders turned a blind eye to costs, but when the price of gold was stagnating in the upper $1,500 to the lower $1,600s an ounce, reining in costs became important. Then came the mid-April price break.

When prices dipped to the $1,320s area, it started to come close the marginal cost of production plus sustaining capital expenditures, called “all-in costs.” Estimates of those costs range between $1,200 and $1,300, analysts said.

“Should prices dip below marginal cost, around 10% of production under our cost curve becomes cash-negative, representing an estimated 262 tons of cash-negative gold production globally,” said Barclays, which puts the all-in costs estimate around $1,300, based on last year’s data.

There is a “trivial amount” of production hedging now, according to Thomson Reuters GFMS, which analyzes hedging. The firm said it hasn’t yet reviewed the fourth quarter, but in its most recent Global Hedge Book Analysis at end-December 2012, the outstanding delta-adjusted hedge book, measuring the market impact of producers’ hedge contracts, was 123 metric tons.

Matthew Piggott, senior analyst, precious metal mining at Thomson Reuters GFMS, said what little hedging that’s done now is related to specific projects as miners seek funds to get production going.

“They need financing and access to the debt market,” he said, adding that those hedges are usually short lived.

Barclays said that it doesn’t expect to see a significant return to hedging. Further, they said, producers would need to believe gold prices had moved into a bear market before turning to hedging again. “Fresh non-project related hedging would be a clear bearish signal,” they said.


For those who want to compare the current gold industry to the 1990s for clues on whether hedging programs will return, Piggott said that wouldn’t be a fair comparison. The 1990s was a difficult climate for the industry with prices low and central banks selling gold without discipline. “It was a different atmosphere back then,” he said.

Thomson Reuters GFMS puts the all-in costs at $1,200, so with prices holding above $1,400 for now, 90% of the miners are still making money, Piggott said. Miners’ views on output have also changed from increasing volume to now focusing on cost containment and seeking quality projects, rather than quantity.

Even if prices fall to the $1,000 area, putting many miners in the red, there wouldn’t be instant action by the industry to hedge or close mines because of the long-term nature of mining, he said.

Not everyone believes that miners will not turn to hedging. Robin Bhar, metals analyst at Societe Generale, said production hedging is going to happen at some point. “We think they have no choice. They can cut expenses, but they might not have a choice but to hedge. Equity holders like the upside they get from the gold price, but at the same time they don’t want the company to be out of business,” Bhar said.

Societe Generale’s commodities team is bearish on the outlook for gold prices and part of the reason is the expectation that producer hedging will put a cap on prices.  “It’s one of the reasons why any rallies won’t be sustained. Companies will use the rally to hedge, especially if prices get back to $1,500-$1,550, they’ll use it as an opportunity,” Bhar said.


CPM Group’s Rannestad said producer hedging would be a “smart thing to consider.” There are other strategies for firms to consider, too, she added.

“For those who don’t hedge the primary metal, they will hedge by-products and focus on that as an effective way to control costs…. There might be more of a push to hedge inputs, like diesel. Some may even hedge a portion of their gold production, maybe 30%, and leave the rest unhedged,” she said.

Sean Boyd, president and chief executive officer at Agnico-Eagle, told Kitco News that it’s a tough decision for companies. Agnico-Eagle “has never sold an ounce forward,” Boyd said.

“Companies need to look at hedging their inputs. You really don’t want to hedge the revenues side,” he said, adding that Agnico-Eagle hedges some diesel costs and also hedges Canadian dollar costs to protect against currency fluctuations.

There is another aspect of hedging that is different now than it was in the 1990s and that’s interest rates are near zero now because of quantitative easing by central banks. That could limit interest in hedging.

“Unlike in previous cycles, any possible producer hedging is unlikely to serve as damper on gold, as it will be very difficult to use traditional forward sales hedging given the credit environment in the commercial banking sector,” said Bart Melek, vice president and director head of commodity strategy, rates and foreign exchange research at TD Securities.

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By Debbie Carlson of Kitco News dcarlson@kitco.com

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.

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