Reuters recently covered the latest Societe Generale/GFMS gold hedge book analysis report, which noted that “while miners overall remain wary of hedging … those who do favour the strategy are leaning more strongly towards options”. The total size of the hedge book has increased from its low of 91 tonnes in Q4 2013 to 193 tonnes at Q1 2015, but it is still massively below its peak of 3230 tonnes in 1999 (see chart below).
After the gold price peaked in 2011, there was industry and media chatter about miners returning to hedging, with Paul Walker of GFMS reported in April 2012 as calling for miners to consider hedging again. As I noted at the time, any “rush by miners to lock in hedges would result in a negative feedback loop, to their own detriment” as not only would the hedging depress the price, but it would encourage speculators to also short sell gold in anticipation of miners returning to hedging.
The topic of hedging appeared in the media during 2013 and 2014 as the gold price weakened further, but it is clear from the chart above that so far gold miners have not looked to repeat the late 1990s where they were hedging into a falling price, obviously sharing the view of Barrick’s CEO Jamie Sokalsky in March 2014 that “he was not interested in hedging because investors want to capture gold’s upside”.
With hindsight one could say that miners should have hedged in 2011 and 2012 but it can be tempting for mine managers to try and speculate as part of their hedging programs, the results of which can be fatal. A recent academic study looked at this practise of “selective hedging” where managers “speculate within the context of their hedging programs by varying the size and the timing of their derivatives transactions based on managers’ market views”.
The paper focused on 92 North American gold miners from 1989 to 1999, which is when the bulk of hedging was talking place. One flaw with my chart above is that it is just the total amount of hedging, which can give an incorrect view of the extent of hedging. The academics therefore look at the miners’ hedge ratio, which “represents the fraction of gold production over the next three years that has been hedged”, shown in the chart below (arrows mine).
What I find interesting in this chart is that the hedge ratio was relatively flat up to the mid 1990s but then increased as the gold price broke down from its narrow trading range. The fall in the gold price would have put some miners into financial difficulties, maybe tempting them into trying to increase the performance of their hedges, so it is not surprising that the academics found that “that smaller firms and firms that are closer to financial distress are the firms that are more likely to engage in selective hedging”.
A timely study considering Metal Focus was reported yesterday as concluding that “on an [all-in sustaining cost] basis, the proportion of loss-making mines at $1,100 swells to 24%”. Metals Focus say that this does not mean that mines will be shut down, as “closing a mine in itself is often a very costly undertaking” and thus “mining companies will often be prepared to operate at a loss in the short term in the hope that commodity prices recover”.
For mines running at a loss it may make sense to look at hedging even at current low prices because it provides protection against further gold price falls – extending how long they can continue to operate and thus increasing the chance they will still be around when the price recovers. While this may make sense for each miner individually, it doesn’t make sense for the industry as a whole if everyone does it. Let’s just hope miners have learnt the lessons of the 1990s.