WSJ on : gold producers -- hedging future gold production or NOT hedging production ...................
COMMODITIES
August 15, 2012, 7:23 p.m. ET
After Gold's Climb, Few Miners Look Down
By RHIANNON HOYLE
SYDNEY -- Brian Rear is an oddity among gold bulls: He is hedging his bets.
Mr. Rear, chief executive of Australia's Millennium Minerals, wants to sell up to half the gold the mining company aims to produce in the east Pilbara -- a dusty, remote part of the Australian Outback -- over the next three years at a fixed price.
While he sees continued life in gold's 11-year rally, he wants to be ready for when prices inevitably soften. "I make no apology for managing our risk," said Mr. Rear. "We don't get emotional about it."
Hedging -- a strategy used to lock in the price at which they can sell their gold in the future -- is common among producers of commodities ranging from copper to natural gas seeking to protect themselves from fluctuations in the market. But it has largely fallen out of favor among gold miners after an almost uninterrupted rise in the precious metal's price over a decade.
Metals consultancy GFMS, a unit of Thomson Reuters Corp., TRI +1.15% estimates only 2% to 3% of annual gold production is covered by hedge contracts over the next three to four years. It says the global hedge book stood at 158 tons at the end of March, up 2.5% over last year, but well below its peak in 2001 at nearly 3,000 tons.
Gold-futures prices began rising from $250 a troy ounce in 1999 to reach almost $1,900 last August. Even after a recent dip, the metal is up about 70% over the past three years. It closed at $1,603.70 on Wednesday.
The world's biggest gold producers abandoned hedging after missing much of gold's lengthy rally. The companies cost themselves billions of dollars when they weren't able to seize on sharply rising prices because they had committed much of their output to hedging at a substantially lower value.
Barrick Gold Corp. closed out its hedges in metal markets over 18 months ago and has been opposed to hedging ever since, as have other big producers like AngloGold Ashanti and Harmony Gold Mining Co.
"Barrick's policy is not to hedge gold," a company spokesman said in an emailed statement. "Our investors want full exposure to gold prices through our shares and we continue to have a bullish outlook for the price of gold."
In 2009, Barrick announced a $5.6 billion hit on its earnings because of the hedging contracts. It opted to sell $3 billion in equity in order to buy out its gold hedges, guessing correctly that prices would continue to rise.
Barrick produces nearly 10% of the world's gold and is valued at more than $30 billion. By comparison, Millennium Minerals has a market value of less than $100 million and has yet to move into production.
Some investors want more miners to follow Millennium's lead, fearing that gold's bull run may soon grind to a halt at a time when production costs are soaring because of higher energy, material and labor expenses. A tumble in the gold price could leave many producers, who have spent billions expanding operations to capitalize on the recent rally, with unprofitable mines.
"I think the industry is being far too dismissive of hedging," said J.P. Morgan Asset Management fund manager Neil Gregson, who oversees around $6 billion of natural resources assets. His point: It is difficult to recognize a peak until it is past.
Already there are signs that gold's rally is losing momentum. As the financial crisis deepened, it propelled the price of gold because it is perceived as a safe-haven asset that tends to do well in turbulent times. It is down more than 10% in the past year.
"Gold should develop sufficient impetus to challenge $1,800 an ounce before the end of the year [but] we expect this to be a 'last hurrah,'" because the global economy should stabilize in 2013, said Robin Bhar, Société Générale's senior metals analyst.
A typical hedge involves a bank agreeing to buy a gold miner's production over a particular period at a set price. It tends to be paid to the miner when the gold is delivered at the end of the contract, but gives the company security on its future cash flow. Miners also use options, which give the companies the opportunity but not the obligation to sell their commodity at an agreed-upon price and can be used to protect against a fall in prices.
To be sure, gold could yet have further to run. Additional quantitative easing in the U.S., or the euro zone's debt crisis worsening could reignite demand for gold and drive prices above $2,000 an ounce.
Still, many miners worry they might end up with burned fingers again if the global economy turns down sharply again and prices surge.
Hedging is "a very emotive issue" within the gold industry because of past losses, said Tim Schroeders, manager of a resources fund at Pengana Capital in Australia, which manages about $1 billion of assets. "But now emotions are getting in the way of common sense."
Locking in prices now could be a smart move, especially if it funds new projects, added Mr. Gregson. That is because traditional pools of finance, including from European banks, for mining projects are harder to come by and equity capital markets have virtually dried up.
But Mr. Rear remains in the minority.
As part of its hedging strategy, his company has locked in the future sale of almost 100,000 ounces of gold from the project near the old gold rush town of Nullagine at an average price of $1,673 Australian dollars ($1,755) an ounce.
"The same investors that complain about hedging are the ones that will be long gone if gold goes back to $800 an ounce," he said. "We're working on a 10-year plan."
Write to Rhiannon Hoyle at rhiannon.hoyle@wsj.com
Copyright © 2012 Dow Jones & Company, Inc.
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