That’s right, I’m talking about gold hedging, the gold stock investor’s bane.
You see, gold miners “hedge” by agreeing to sell a portion of their future gold production at a fixed price. That way, if prices fall, they’re guaranteed a better profit.
Hedging was all the rage during the late 1990s and early 2000s, a period in which gold lost more than half its value. At the time, even mining company executives didn’t think gold prices would move up.
But with most of their production hedged at relatively low prices, many miners missed out on the gold price boom of the last decade.
And now, gold hedging is once again making financial headlines.
Hedging’s Back on the Menu, Boys
Russia’s largest gold producer, Polyus Gold International (PLZLY), just announced a two-part hedging program at the beginning of July, the first instance of gold price hedging in six years.
Interestingly, the most recent hedge is also the biggest by a producer since the European central banks agreed to limit their gold sales back in 1999.
In the first part, Polyus agreed to forward sell 310,000 ounces over the next two years at a price of $1,321. The second part involves Polyus hedging 2.52 million ounces through the use of options, covering the next two years. The options will protect the company if the price of gold falls below $1,375 an ounce.
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Polyus said the hedge was put into place to increase the certainty of cash flow as the company invests billions of dollars to bring the Natalka field online, which is one of the world’s biggest untapped gold deposits.
Is This the Start of a Trend?
That makes sense for Polyus… but gold stock investors are worried that this is the beginning of a larger trend back toward hedging.
At the moment, there’s no need to worry. The global gold “hedge book” ended the first quarter at a mere 87 metric tons. That’s just 2% of the gold mined annually, and is well below the 1999 peak of 3,000 metric tons.
Plus, for most producers, the taste of being burned by hedges during the 2000s is still fresh, and shareholders would undoubtedly raise hell with management over a major hedge.
Finally, it doesn’t make economic sense to hedge right now, as there’s very little contango in the gold market. That means there’s no large premium that can be locked in if producers sell their forward production.
The major producers like Barrick and Newmont Mining (NEM) are likely to continue cutting their production costs and investing in capital projects that promise a good return, but for large gold producers, hedging remains off the books for the foreseeable future.
And “the chase” continues,