Issue 37

Dead? Buried? Dormant? Resurgent? : A Prehistory of Gold Hedging in the 21st Century

By Paul Merrick
VP, RBC Capital Markets

Paul Merrick examines the history behind the current state of gold hedging. He asks what – if anything – could cause the situation to change, and how any future hedging activity might differ from that of the past.

These days it is rare to see the words ‘gold’ and ‘hedging’ in the same sentence. With gold’s recent rampant price performance and producers rolling in cash, this pair of previously intimate bedfellows seems set to remain estranged for the foreseeable future. Legacy positions are being bought back or allowed to roll off, new hedging activity is linked almost exclusively to project finance, and even then only when required by lending banks. The total of delta-adjusted producer hedges is currently around 7% of overall reserves, down from a high of 13% in 2000 – the lowest level since large-scale hedging began in the 1980s.

From Base-Metal Basement to Golden Phoenix

What caused sea change in the - management policy of mining companies? The seeds of change were planted in 1999. In that year the US stock market was booming and the dollar appeared to be the universal store of wealth for the 21st century, while gold had become a quaint anachronism, a throwback to the days when the value of a currency had to be backed by something tangible instead of being allowed to sink or swim in an ocean of issued paper and exchange-rate speculation. Gold seemed to be heading towards the status of just another base metal.

In May the Bank of England announced plans to sell 123 tonnes of gold. While not a significant quantity, the action seemed to confirm gold’s demise as a store of wealth, and the price slumped to $253, the lowest in 20 years.

In this environment of depressed prices and dismal prospects, it seemed unthinkable that gold could ever rise, phoenix-like, from the ashes of its obsolescence. But the confluence of three influences created just such a renaissance.