Gold investors urge caution as miners consider return to hedging
Investors in major gold miners reckon a return to hedging could rob them of the chance to reap the rewards of any price rebound.
Posted: Thursday , 12 Dec 2013
LONDON (Reuters) -
Investors in major gold miners say a return to hedging future production after a slump in gold prices would be a sign of financial weakness in companies and could rob them of the chance to reap the rewards of any price rebound.
The incoming chairman of Barrick Gold, the world's largest gold miner, last week rekindled the debate over the practice of selling production forward. John Thornton, a former senior executive at Goldman Sachs, said he would seriously consider hedging.
Money managers say hedging could play a limited role, particularly for smaller producers, but would raise concerns about players such as Barrick.
"The act of hedging is a sign of balance sheet weakness," said portfolio manager Catherine Raw at BlackRock, the world's largest asset manager and a major gold investor.
"It's a sign that debt-holders are requiring them to protect themselves from the downside, because their existing balance sheet and projects are not robust enough to cope with any further fall in the gold price."
Less than a decade ago, major producers including Barrick and AngloGold Ashanti had to spend billions of dollars unwinding hedged positions after a soaring gold market left them selling metal at well below spot prices.
Barrick raised more than $5 billion in 2009 to unwind its fixed hedge book and has since stuck to a no-hedge policy.
AngloGold, which paid $6 billion to buy out its hedges, said earlier this year it had no plans to return to the practice. The miner declined to comment for this story.
But investors say that even this year's 25 percent plunge in gold prices - their biggest annual drop since 1981 - should not sway miners.
"Any company that hedges would basically be starving itself of the opportunity to benefit from the next upturn in the gold price," Angelos Damaskos, chief executive of Sector Investment Managers, said.
Hedging was a common practice in the 1990s and beyond, when gold prices were pinned in the $250-$400 range.
At the time, it seemed a good strategy. Mining firms could guarantee future revenues and plan their expansion accordingly. But as the gold rally took off around 2000 and prices surged by six times to peak in 2011, it proved costly.
Some smaller miners are still hedging. Data from metals consultancy Thomson Reuters GFMS showed that companies such as Vancouver-based B2Gold Corp, Minera Frisco and OceanaGold all increased hedges this year.
Temporary hedging may help junior miners in seeking project finance and others in facing short-term operating issues, but such a move must be carefully presented to the market, ING Investment Management's Frederic van Parijs said.
"We've seen some hedging already this year, especially from some of the more challenged junior players. That has not been rewarded by the market," he said.
"The market sees that while you may be safe for six months, 12 months, it's not going to bail you out if you are operationally challenged. The best way out is to get your operations in order."
The global gold hedge book shrank dramatically over the last decade, from over 2,100 tonnes at the end of 2003 to just over 96 tonnes by the middle of this year.
But the pace of de-hedging has slowed considerably, and proponents say that, prudently used, it can be a valuable means of securing income on some projects and improving cash flow.
Even with increased debate, miners are likely to use hedging on a much smaller scale than they did before 2000 and for shorter periods, compared with years-long contracts in the past.
"The problem the gold industry had in the past is that they literally took all of their entire reserves and hedged that fully out," said John Goldsmith, Montrusco Bolton Investments' deputy head of equities.
Miners should use a more moderate approach, as seen for some mid-sized oil companies, he added.
"What the oil and gas industry does is guarantee a minimum amount of cash flow for their current year's budget so they can actually pay for certain capital expenditures," Goldsmith said. "This is definitely something that the gold industry should be adopting by putting certain types of hedges in place."
In a note this week, Barclays Capital said while it believes that a large-scale return to gold hedging is unlikely, a switch back to hedging on a net basis is increasingly on the cards next year and into 2015.
If hedging activity by gold mining industry did pick up, it could also prove a further drag on prices, because it would bring forward supply. Miners typically hedge by leasing gold, usually from central banks, and selling it onto the market.
But hedging of a scale that would seriously affect prices remains a distant prospect.
"I can't imagine we will ever go back to the levels of investment that we saw previously - maybe for, say, a quarter of production and short term for next year - but I can't see investors wanting to limit their upside (exposure) to the gold price," Kate Craig, an analyst at Liberum, said.
"It will be restricted in terms of timing but also to those companies that are heavily indebted," she said. "If you don't have balance sheet issues, why bother hedging?"