By Sean Russo
Principal and Joint Managing Director, Noah's Rule

The trend is your friend. Not strictly true if that trend is going against you, but if you take the broader interpretation – to respect the prevailing trend – it’s generally very good advice. At Noah’s Rule, we prefer the slightly extended version. The trend is your friend – until it ends. No BFFs in financial markets.

Too Much Is Never Enough

Trends are clearly not limited to markets, but often the prevailing trend in one market will drive associated trends in financing/funding in that market. The longer the underlying trend goes on, the more deeply entrenched processes and behaviours become. So it was with gold producers and hedging in the 17 years from 1985 to 2002. The trend was not their friend, but hedging clearly was. Until, in the following decade, the messiah became the pariah!

It must be noted that in the dying years of that nearly 20-year gold bear market, there were few market participants that remembered a time when hedging wasn’t a major part of the game. The largest ever addition to the global hedge book was in the quarter when we saw the lowest price of the down move. At its peak, the industry’s observable commitment to hedges was equivalent to one year’s global production. What was not understood widely at that time was that undeclared and/or poorly understood derivative obligations made it larger still. Looking back, we know well that the tail began to wag the dog! That’s what deeply entrenched trends do to behaviours.

It’s instructive to read Randall Oliphant’s article “The Hedging Advantage” (see Alchemist 12, June 1998), which hasn’t aged as well as the fine wine he compared Barrick’s hedge book to. By the mid 2000s, as gold prices were finally rising after two decades in the financial wilderness, it was very easy, and indeed very fashionable, to criticise gold miners, many of which had built substantial business despite falling gold prices, but now had large loss-making hedge books. However, for most of the previous two decades and indeed even well into the early 2000s boom, if you wanted to borrow money to build a mine, you had to talk to banks and banks required clients to hedge. Just like banks prefer to provide home loans to people with steady jobs (oh, except for those NINJA loans in the 2000s), they generally like to know a mine has some prospect of achieving the future prices that are being plugged into the spreadsheet today. Hedging provides that.

To remind yourself how capital hungry the industry was in the late 1990s, Michael Simon’s article “Financing Mining Projects” also in Alchemist 12 is a great read. The last few paragraphs are awesome! “The debate (on hedging) will doubtless continue for some time” and “ should be noted that the use of derivative instruments has enabled a number of projects that were marginal or unprofitable to obtain financing.” And the conclusion. “The intricacies of mine financing are formidable, and can easily be, misunderstood. As a consequence, they are often misused” Gold Michael, gold!

As we moved deeper into the noughties and gold consolidated its new uptrend, investors came back but they didn’t like the vestiges of the dark days of the 90s. Fresh equity was raised by the tens of billions. Instead of delivering mined gold into hedges, gold miners mined the equity markets, raising cash to buy gold bars in the spot market to meet forward sales. A vicious (for some) circle was created. Large time-sensitive hedge buy-backs helped to push the gold price higher. Many investors seeing gold prices rise and observing gold producers buying gold decided that they were better off buying gold than gold shares and the newly created gold ETFs facilitated that. (Nik Bienkowski’s article in Alchemist 48, October 2007, is a good read on those early days).

The higher the gold price went, the more costly the next hedge book buy-back became – requiring even more new shares to be issued. The fewer the miners that still held hedging, the greater the urgency was to join the new ‘unhedged’ crowd, creating more and more shares backed by no more in-ground gold than had been there at the start. As a consequence, many gold stocks underperformed gold, and hedging became a dirtier and dirtier word. Gold of course was in a fully fledged bull market.

Exploration increased, higher gold prices begat new mines and allowed old mines to be dusted off, all requiring finance. But with hedging pushed to the corner, a new form of debt was required.

Banks, displaying their characteristic conservatism, still needed hedging and were marginalised. Mining entrepreneurs and equity investors still wanted leverage and that required debt. It should be noted some of the up and coming mining houses of today owe their tight capital structures to the benefits of debt and hedging taken on in 2010-12 when they were starting out.

Anything But Hedging!

Enter the streamers. A line of business that had started as a way of letting base metal miners with precious metal credits tap into the premium that precious metals equities had previously enjoyed, before they so solidly soiled their own nest, became mainstream. Streaming moved from cash for by-product stream to cash against primary product. Aspiring gold miners could stream their gold. Instead of borrowing money and locking in a certain gold price to ensure they could repay their loans, aspiring producers could give away the right to a share of future gold production for enough money now to finance construction. One big difference was that, whereas hedging was locked in for the period of the loan, streams were for the life of the mine.

Annual percentages of commitments were generally smaller, but obligations were in some cases only limited by the miner’s capacity to not keep producing. Some investors scratched their heads and wondered what the difference was (and the smarter ones bought shares in streamers). But all that seemed to matter, certainly in North America, was that streaming wasn’t hedging and it was the new normal – the solution du jour.

One emerging streamer even started its presentations with a coffin on the first slide, announcing the death of conventional debt and hedge finance. Bankers, fearing it might be true, loosened standards. Debt without hedging (or hedge-lite) became a thing and gold prices looked rosy in any event.

Somewhere in all of this in about 2011/12, over a decade after the first (and to our recollection only profitable hedge buy-back), the gold price stopped rising. But not so debt levels, which kept rising along with a steadily increasing obligation across a growing band of producers to surrender a not-insignificant share of future production for either no future payment (royalties) or a payment that was a fraction of what gold was now costing to produce.

Not All Ounce Commitments Are Equal

Today, the top five royalty/streaming companies report annual gold and gold equivalent sales of approximately 1.1 million and 1.5 million ounces per annum respectively. Those numbers are forecast to grow in coming years. That’s about 1% to 1.5% of global production. There are only about ten major mining companies that produce more than that in a year. To the extent that royalty/streaming is often done to avoid dollar-based debt and associated hedging, it is interesting to contrast the streamer outputs with the hedge obligations of those that have still taken the debt/hedge path.

In 2019, the total outstanding hedge obligations were estimated to be in the order of 7 million ounces and are estimated to have dropped towards 5.1 million ounces by the end of 2020. If hedged producers have an average hedge price of around $1,500/oz, the revenue forgone at current spot ($1,850), the hedge loss, is in the order of $1.8 billion, but they will still receive $7.6 billion for that gold when delivered. Using standard metrics – we generally observe that debt service might be assumed to be a third to a quarter of hedged revenue in the same period.

That suggests that $1.9 to $2.5 billion of hedge-associated debt service, with $5.1 to $5.7 billion net sales proceeds, still hitting the bank account of the hedged gold producers, mostly over the next two years.

It’s hard to get a breakdown by ounces between commitments to royalties versus streams. There are certainly less streaming transactions by number, but the volumes are much greater.


If we look only at gold streams and assume the future ounce commitments were 75% to streams and 25% to royalties, and take a stab at the average future stream payments for delivered metal being 25% of spot price, then those miners who granted streams/ royalties will deliver in the order of $2billion of gold for cash $380 million; implying equivalent “debt service” of $1.6 billion per annum for the foreseeable future. (The 75/25 split is a guess. If the royalties percentage is larger the cash back would be lower). It’s worth reading those last two paragraphs again.

Yes, hedges give up price upside, but streams and royalties give up revenue and for much longer. Whereas hedging is designed to support debt that helps to reduce equity dilution, streaming by its very nature dilutes shareholders exposure to the gold price but at the asset level. One is not better than the other. Each has its advantages and disadvantages, but the long term impact of dilution early in the life of any mine or company should never be underestimated.

It also worth noting that there is an important distinction, in my mind at least, between royalties when used to fund pre-production activities like exploration and feasibility studies and streams used as an alternative to dollar-based debt to build mines. The wonderful graphic from Refinitiv showing the number of the companies at various stages that have royalty or streaming deals, which gives a very interesting view of just how entrenched these products are across the spectrum of the industry. The number of smaller providers that have appeared in that space in recent years speaks volumes with regard to the observed returns in the sector. Royalty/streaming companies are loved by those who invest in them but viewed more warily by many of those who seek to invest in emerging producers.

There is no doubt streamers remain an important part of the ecosystem, as do bankers, but we can’t help thinking that before this next gold price cycle has run its course, future obligation to streaming transactions done some time before, will be as disliked by gold-mining investors, and miners with streams, as hedging and bankers who provided it, were in the noughties. We will not be surprised to see deals done to unwind streams and equity investors will again carry the can!

There's (Another) New Kid In Town

Enter ‘the funds’. The idea of large endowments and pension funds investing in vehicles directly lending to emerging miners was almost unheard of, even when the streamers were really gearing up. Fixed obligations and ZIRP (zero interest policies) going global created fertile ground for savvy entrepreneurs to tap this huge source of interest-income hungry investors.

The funds saw a niche. They recognised miners (and more importantly, their key investors) had now figured out that giving away a share of your production for the life of the mine to streamers could be troublesome in both rising markets (investor backlash) and falling markets (the operating cost burden on the remaining ounces when operating margins shrink).


They also saw that while banks were still active, they were more credit-sensitive than ever and only a hardy band of Aussies and Russians (with a few notable exceptions) understood how to make hedging work for them and their lenders. They crafted the new ‘new normal’ – debt at a higher rate of interest than banks were seeking, but without the protection of hedging for lender or borrower. Life-of-mine ‘kickers’ linked to production, but much more modest than streamers, added some additional return to meet the lenders’/investors’ risk-reward hurdle.

Being able to move smoothly over the capital structure, they make a promise to invest directly into the companies they fund, putting ‘skin in the game’, making them a ‘partner’. They have totally changed the landscape.

Ironically, it’s hard not to imagine that this is how gold mines were financed in Roman times. Everything that is old is new again. Low interest rates are said to be good for gold. Money printing is surely good for gold prices. Those whose assets suffer badly in a low interest rate/money printing environment would be wise to own gold, but their biggest problem is that it still pays no yield. Lending money to miners does. Lending money to aspirant miners pays more still. And if as part of the deal, you can get ownership of gold in the ground at a fraction of the spot price, we should probably all hope our pension funds have at least a modest allocation.

Spoiled for Choice - What Might You Do?

When we are engaged to help a company formulate a funding plan for a new mining development, we always start with the three same questions: What might we do? What can we do? What must we do?

We also remind clients that while the basic questions around risk management and funding approaches remain the same, the answers keep changing – sometimes more than once in the timeframe between finding the ore body and producing the first ounce. Some of those changes might relate to the risk profile of the particular project and/or where the product price is in its own cycle.

The state of the currency of the country of domicile can also have a big impact, but usually the biggest question is: Where will the money come from? What we can do and what we might do alter considerably depending on whether the sources of funds are tight or money is plentiful.

Today, aspirant gold miners are spoilt for choice. The range of answers to ‘what can you do?’ has never been broader. But answering ‘what might you do?’ is no easier. The cost and availability of money has not made building and running a gold mine any easier. The multiple potential physical, technical and financial contributors to the potential ‘risk of ruin’ remain the same. Good management will continue to make a silk purse out of a potential sow’s ear and poor managers will continue to cripple all but the most foolproof of assets.

None of the funding approaches are better than the other. All can and have been used successfully at different times, against different trends, in different ways to create enormous shareholder wealth and to the benefit of all stakeholders. All remain relevant, and competition is clearly a good thing for borrowers.

As for ‘what must you do?’, most of that will be set out by the lenders’ lawyers. We would only add that, in our experience, what you must do is remember that as you debate the ‘what might you dos’, those at the table who are so convinced of where the gold price will go next are possibly the most dangerous people in the process.

Whatever funding is chosen, never forget the journey risk. Today, you can see the trend, but no one can tell you when it will end.