When a producer of a commodity sells forward, he is locking in a price today for delivery of the commodity sometime in the future. The producer knows his cost and by receiving a quaranteed price one year out, he is eliminating the uncertainty of whether he is going to make a profit. Most transactions of this type have little impact on the physical amount of the commodity available to the market at the time of the transaction.
What is unique among the gold producers, a forward sale can be structured in a way that additional amounts of the commodity are available immediately at the spot market. The increase in supply can and in the case of gold has had a depressing effect on the price of the metal. By borrowing gold from the cb's and selling into the market, the companies generate immediate cash on a sale that is slated to take place sometime in the future. The funds can either be invested or used to develop new mines. The reserves of the developing mines are used to guarantee the leased gold. Unfortunately, the terms for the leased gold are short term and can be rolled forward into perpetuity. The rolling out of the contract maintains a higher level of gold available to the market. The net effect, the price of gold being reduced by the additional amounts of supply is stabilized at the lower price with the additional gold mined thru new production. As the duration of the low pog is prolonged, the company engaging in the forward sales finds themselves in a position of selling their reserves at a reduced cost which may be near the cost of production. When factoring in the cost of the mine, the company can easily be relegated to the unenviable position of depleting their reserves at a low price that places the company at risk. The outstanding liability for the leased gold remains on the companies books waiting a potential call from the lender of the outstanding loan. Some of the producers have found themselves in a position that they could not afford to purchase the required gold to close out their position.
In another scenario, if the funds procured from selling leased gold are invested into bonds for potential investment income, the company holding such a position is vulnerable both to interest rate risk and the pog going against them.
The hedging techniques employed by the gold producers contains considerably more risk than the hedging techniques used by the producers of most other commodities. It is interesting to note that the producers of oil, and the base metals are able to run their business, conduct exploration, and build new mines or wells, without the atruistic funding that the gold producers get from the cb's that are more than willing to lend them gold at an annual interest rate of less than 1%. Such generosity from governments that are know to wring every last dollar they possibly can out of large business. Boy are the gold producers lucky to have such generous benefactors.
Ken |
