Always looking for negatives to report about gold, the media is now talking about “a return to hedging,” with the suggestion that gold miners are about to dump on the markets huge quantities of yet to be mined gold. Nothing could be further from the truth.
Hedging occurs when a miner, or a gold reclaimer, sells futures contracts at prices that lock in profits for gold that is yet to be mined or reclaimed. Although hedging “locks in profits” and protects against lower prices, it also precludes the seller from profiting from higher prices. As Keith Weiner of Monetary Metals, noted in his Selling Low and Buying High: Hedging by the Gold Miners, gold miners are not any better at predicting gold prices than anyone else.
More than a decade ago, when gold was in the $300 range, Barrick Gold, one of the world’s largest gold miners, sold forward what was reported as “years of production,” only to have to pay $6 billion in later years to unwind those short positions. Forward sales/hedging are short positions, meaning that the sellers are “short the commodity sold forward.” In other words, they don’t own what they sell.
In the case of miners, they own gold; but it is in the ground. When reclaimers of scrap gold (usually refiners) sell forward future production, they don’t even own the gold, they just are just counting on the gold coming in based on past history of how much scrap gold they buy.
Reclaiming scrap gold is a huge industry, that is why WE BUY GOLD signs are ubiquitous across the country. Reclaimed gold makes up about a third of annual available gold supplies, which is right at 120 million ounces.
After gold topped $1900 two years ago and now is trading the $1300 range, why would miners hedge now and not two years ago? Because, as Weiner noted, the people who mine gold are not any better at forecasting gold prices than anyone else. Think Barrick Gold.
Or, remember that fifteen years ago the Bank of England–right at the bottom in the gold market–announced that it would sell 415 tons, about half of its gold holdings. The BoE has extensive research capabilities but could not accurately predict the future price of gold. When the BoE announcement was made, the lead article in our hardcopy August 1999 newsletter Monetary Digest was titled Gold at Fire-Sale Prices.
Recent talk about renewed hedging surfaced at two bullion banks. “We’re seeing more genuine hedging in gold than we have for some time,” said Martyn Whitehead, Barclays’ head of metals and mining sales. Société Générale, another financier of the mining industry, said in a recent sales note to clients that miners were “queueing [up] to bullion banks to discuss short-term hedging arrangements.”
Actually, it’s only a few “junior” mining companies with small production that are talking about hedging. None of the major miners, such as Barrick Gold and Anglo-Ashanti, which had their heads handed to them on silver platters with earlier hedges, have disclosed any intents to hedge. The juniors, with less financial wherewithal, may be making the right decision to hedge because still lower gold prices could sink them. Better they lock in at least some profits. (Some analysts assert that gold miners cannot operate profitably at $1200 gold.)
“Even if the miners hedged by selling 100% of their annual output forward,” said Weiner, “they would add but a small and temporary amount to the gold stocks. And of course they would not sell all of their production, but only a part of it. Hedging will not affect the price of gold.”
Regardless, going forward gold investors may have to put up with a lot of hype about hedging. But, they need to know that hedging of the volume seen some ten years ago is not in the cards. And, they need to remember that all hedged positions have to be bought back in the future, which will add to demand.
