Here'tis, honey...jist fer you: Mechanics of Hedging-101
For starters,
Let's make some basic assumptions here.
1) Barrick is a BIGGIE, a 3 MILLION oz per yr producer.
2) Owning ANY precious metals' reserves and pouring gold is nothing more than a private mint!
3) SWC is a lil' outfit, a _____thousand oz per year producer.
4) Big outfits exert more clout in the deriatives market, aka Futures and Futures Options Market, than a lil' SWC can exert.
5) COMEX commodities futures contracts are only open for 2 years out...in other words, you can buy/sell Feb GOLD 98 thru Feb GOLD 2000 only through NEW YORK Comex.
6) COMEX gold contracts are ONLY available in 100 oz sizes.
7) LBME gold contracts, such as traded on their Massive Over The Counter Market size is not currently known to me, but I am assuming the NY 100oz is available a/w/a larger Oz size contracts.
8) LBME is not transparent/trackable/covert gold market & 10x the size of COMEX.
With me so far?
Now, since 1 & 2 are true,
then Biggie outfits have 2 things going for them that the lil producers don't:
1) Biggies have personnel to "throw at" the hedging process, a separate, specialists' staffed dept if you please.
2)Biggies who own the money printing processes as representated by larger reserves, can take more risks than lil' outfits. How that transfers into the Hedging Arena is this:
Biggies don't just employ hedging techniques, they also SPECULATE, i.e., gamble on gold they haven't yet produced just to take advantage of their ability to throw size at the market and make things "go their way" thus picking up a few extra zillion dollars over time.
EXAMPLE:
Barrick produces 3Mil per year.
3 mil oz. divided by the 100oz Comex Standard Gold Contract size=300,000 contracts just to cover 1 year's production.
What would you surmise if you learned:
Barrick had 3 MILLION SHORT COMEX GOLD contracts still open?
A) Barrick has hedged 10 years of 3mil oz production?
B) Barrick has hedged 5 years production and gambled on 5 "extra years production to make a profit on the weighty SHORT they put on?
C) Barrick has hedged 1 years's production and gamble on 9 extra years of production?
D)None of the above.
E) A, B, or C.
Now, let's add the next step in your understanding of the process, if your eyes are not glazing over(grin)
When a short sale occurs in a true hedge,
a PRODUCER
synthetically sells
the equivalent amount
of an ACTUAL contract/purchase order so to speak,
in the FUTURES MARKET,
EQUAL TO the same amout of gold contracted for delivery
to an actual customer who wants delivery in the future
based on said customer's fabrication schedule, say in electronics or jewellery.
The customer wants the lowest price, the producer the highest price.
That is a given.
When the sale is actually consumated by delivery of the gold to the customer, the synthetic sale is supposed to be lifted,
i.e., the EXACT AMOUNT of GOLD FUTURES BOUGHT BACK,
and the hedge is "closed out."
However, if one has sold gold at $530 per oz to a customer, who wants delivery Feb 99, then the producer has to short a gold contract at $530 in 1999 IF SAID FUTURES CONTRACT PRICE POINT IS AVAILABLE.
What if it isn't?
Then said producer effects a SYNTHETIC synthetic short sale, by writing $530 strike Feb 1999 Gold CALLS. When MINER delivers said gold to customer in Feb 99, then s/he should go in and buy back her/his short gold call, and the hedge is closed.
All too often, the hedging departments don't do the simple...they GAMBLE on the effect of their presence in the Gold Futures and GOLD FUTURES OPTIONS MARKET, as well as their own stock price, and push the envelop, if you please. Such virtual hedging, is what is part of the multi-trillion dollar bubble currently in the commodities markets, such as was addressed in that Jones Report on the GPM thread ystdy.
Now, if I haven't totally lost you,
let me summarize, by saying this:
Biggie outfits have the personnel, skill, and time to devote to such machinations.
Lil' outfits don't.
The least "gamble/speculative..."
the most responsible to shareholders position,
the fairest to the customer and producer,
is to sell what you produce,
when you produce it
for a fair price
and then just keep on producing and selling.
Such seems to be the modus operandiof SWC.
Seems NOT to be the MO of ABX.
Who is truly "hedging risk" in this real life????
In my opinion???
The SWC's of this world who are working on CASH FORWARD CONTRACTS,
& NOT utilizing the Futures derivs. or the Futures OPTIONS derivs.
My second choice is the true hedger!...
A producer who is utilizing the straightforward futures contract hedge and resists the urge to gamble.
In the case of SWC, I suspect they are basically CASH FORWARD CONTRACT Palladium producers.
As such it takes a while for the "profits" to show up in their bottomline, and thus in the pockets of shareholders.
However,
what do THEY get in return for their reliability as a producer?
Selling all they can produce,
At a profit,
At all times,
in a politically "stable" economy/geographically
PLUS a waiting list of customers ALWAYS wanting more!
Ole "instructor" 49r
P.S. Oh, and don't forget,
the Futures Markets are also full of
BUYERS/USERS of GOLD/PLAT/PAL/SILVER,
using the HEDGING features for themselves at all times, as well,
and also gambling to beat all hell!
So,
abuse of hedging is not just an ABX and other Sellers' game...
Buyers/Users abuse Hedging, also. |
