GOLD-- Gold Hedging by Producers-- April 28, 2002
The Price of Gold Is Shining. Hedging of Gold Is Not.
By JONATHAN FUERBRINGER
The performance of Barrick Gold's stock shows that the sentiment of the gold market has swung sharply against hedging.
Hedgers and anti-hedgers have been battling for years. Hedgers lock in the current price of gold, plus a premium, by borrowing gold, selling it and then investing the proceeds. They say this is good management and smart protection against a price decline. Anti-hedgers are more bullish on gold, saying hedging prevents a company from reaping the full benefit of a price rise. They talk much less about the downside risk.
The shift on hedging is important to gold investors, who can now be more certain that the stocks of anti-hedgers will have momentum if gold prices continue to rise. Those who advocate hedging — and who have done very well with their strategy in recent years — will be under pressure to do less of it. An increased focus on the gold price is likely to diminish concern for a company's fundamentals, and that is not a good long-term strategy for investors.
So far this year, the stock of Barrick Gold, the third-largest gold mining company and a leader of the hedging faction, is up 27.8 percent, as the price of gold has jumped 11.9 percent. Sounds great. But the Chicago Board Options Exchange index of eight gold mining companies is up 42.4 percent for the year, and Newmont Mining, the largest gold mining company and a leader of the anti-hedgers, is up 57.4 percent.
As the price of gold has risen — it hit $312.10 an ounce on Friday — the argument against hedging has become so persuasive that an anti-hedging reputation is what really counts these days when investors pick gold stocks.
Newmont actually has a large hedge position right now, gained with its February merger with Normandy Mining of Australia. But that has not hurt Newmont's shares. Barrick, meanwhile, has moved to be less hedged in the short term. It will now sell half of its 2002 production at spot market prices, shedding its practice of hedging all its current production. But that shift has not helped Barrick in the stock market.
"The distinction now seems to be drawn more along philosophical than factual lines," concluded the 2002 gold-market report released last week by Gold Fields Mineral Services.
The move away from hedging is clear. Last year, the amount of gold hedged plunged by 147 tons, or 4.7 million ounces, after a modest 15-ton decline in 2000 and a 506-ton increase in 1999, according to Gold Fields Mineral Services.
The downturn helped start the rally in gold prices this year. Unwinding of hedges requires buying of gold, helping to push prices higher. That has led to less volatility in the market and allowed producers to think more about the upward potential for gold, making hedging even less attractive.
In addition, the Gold Fields report said a decline in interest rates last year narrowed sharply the premium a company could earn by selling gold to hedge. By the end of last year, that premium was down to $2.47 an ounce from $15 an ounce in 2000.
Randall Oliphant, president of Barrick, said the battle over hedging "is a bunch of nonsense." But it is not, because it is having an impact on his stock.
He does fault himself for not getting Barrick's message out. "We know how much we benefit from a rising price of gold," he said. "We have to do a better job of convincing people of that."
His problem is that Newmont gets a bigger benefit because it has more unhedged gold to sell this year. A $25 climb in the price of gold this year, to $325 an ounce, would mean $71 million in added revenue for Barrick but would bring Newmont $156 million.
Bruce D. Hansen, chief financial officer of Newmont, said there were two reasons to own Newmont: to speculate on a gold rally or to bring diversification to your portfolio.
This is not betting on a company because it is well run or focused on earnings. It is a bet on gold. While the price of gold dropped nearly 19 percent from 1998 to 2001, Newmont suffered through four consecutive years of net losses. Barrick, which was hedged, had a loss in only one of those years, and its stock fell less than half the 35 percent decline suffered by Newmont.
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