Issue 89
Hedging On The Up
In the mid 1980s, Australian gold producers were some of the first to embrace hedging. Hedging allowed entrepreneurs to access debt to develop mines where previously only large companies had been able to access capital.
In 1988, the news of Newmont’s 1 million ounce gold loan knocked the gold price down but also really got the ball rolling on the use of hedging by North American miners.
As prices fell over the next decade and pressure on margins increased, more and more miners sought salvation in increasingly complex gold derivatives that seemed to solve the problem of the day but generally heavily mortgaged an already uncertain future. At its height in December 1999, the global gold producer hedge book (see chart 1) was reported as nearly 106 million ounces (3,305 tonnes).
Anybody with even a passing interest in the gold market and gold equities is all too familiar with the incredible sum of money shareholders were required to stump up between 2002 and 2012 to close out hedging largely instigated before that period.
By the time producers finished their buy-backs, the global hedge book had hit lows of 2.5 million ounces in December 2013. No wonder hedging copped such a bad rap, with producers collectively maxing out at the low and buying all the way to the high.
Nearly five years on, the global hedge book has slowly increased to around 7.5 million ounces (having briefly reached 9.5 million ounces in June 2016). Australian gold producers are again some of the most active, with the other large contribution coming from Russian producers.
While several North American companies have put a tentative toe in the water, the hedges have been generally tied to specific events (e.g. New Gold and Rainy River Development) and over relatively short periods. In almost all cases, these companies have been at pains to say they are not otherwise returning to hedging in the ordinary course of their business.
There is no doubt in our mind that the enormous growth in the penetration of debt funds has also contributed to lower levels of hedging, as debt funds have both crowded out the traditional lenders who have historically insisted on hedging alongside their loans and made it exceedingly difficult for their borrowers to do any hedging.
In December 1999 the global gold producer hedge book was nearly 3,305 tonnes
In the case of Australian and Russian producers, currency weakness in the period after the USD gold price collapsed in 2013 allowed companies a chance to lock in very favourable gold prices in local currency terms. Having looked into the abyss in 2013, the more geared or high-cost producers were quick to move back to hedging when the potential to lock in solid margins in local terms was presented. Interestingly, Canadian-based mines have also enjoyed the benefits of a weaker currency, but they seem to be far more influenced by a USD-centric view of the world, so like their southern neighbours, they have largely ignored the opportunity to grab some revenue stability in what have been very volatile times.
Today’s hedge books in Australia are relatively modest (see chart 2). The average hedge book of the producer group shown here is 200,000 oz. Expressed in as equivalent months of production volume in the table below, it is equivalent to 6 months of average production1. The vast majority of producers have an average currently realisable price in the range of $A1,650 – $A1,725. A very solid price level if you consider that the AUD gold price has only closed above $A1,700 in 10 months in history and in only eight months since the collapse in 2013. We have also observed the industry average hedge price rise steadily over time as spot prices have risen, which is very pleasing.
This suggests that most producers are acting responsibly, dealing promptly with their lower hedges and being disciplined both with the prices they add to cover and the volumes that they add. It’s all about securing margins to work their balance sheets harder, not punting on the gold price.
On visits to North America last year, we met with or saw presentations by more than 50 producers. Overwhelmingly, they still quote shareholder interests as their prime reason for eschewing hedging.
Indeed, the one question we were often asked was ‘how do Australian miners get away with it?’, followed by the statement ‘if we hedged, we would be punished in the equity market’.
The irony of course is that several of the leading miners in Australia who regularly hedge are trading at or close to 52 weeks and, in some cases, near all-time, highs. Far from being punished by investors for hedging and ‘giving up the upside’, Australian miners who hedge are increasingly being rewarded for showing how they have taken advantage of the more predictable revenue streams (and margins) that hedging allows, reducing debt, drilling hard, and increasing reserves and paying dividends.
Right now, the gold price looks good in almost all currencies. Unhedged gold producers may play catch-up on their hedged rivals if gold prices really take off from here. However, with only six months of production hedged, and at prices that are locking in what are close to record operating margins, the overall negative impact of higher prices on the hedged producers will be limited. On the other hand, if gold prices again roll over, the hedged producers will have much more time to react and adjust. It’s this latter point that seems to be dawning on those investors that are recognising the advantages delivered by miners that hedge sensibly.
The current hedging landscape suggests some encouraging conclusions (see chart 3). Most encouraging is that the hedging being done in recent years is not like the hedging done in the 1990s (either in size, price or complexity) and, equally, that the majority of companies that do hedge are managing their hedge books in a disciplined and strategic manner. In 2018, the vast majority of gold hedge books are doing what they were always intended to do – providing stability and predictability in a volatile and ever-changing market.
Noah's Rule PTY LTD
For more than 13 years Noah’s Rule has been providing tailored expert Market Risk and Debt Advisory services to the global mining resources and importer and exporter communities. The firm is known for its frank, robust approach across metals; currency; interest rate and debt markets as well as capacity to help companies gain clarity in uncertain environments. As well as helping firms manage their long-term strategic positioning in these markets the firm also provides benchmarked weekly short-term trading advice across a broad range of markets.
Sean Russo, Principal and Managing Director, Noah’s Rule. Sean is passionate about helping companies manage market risk to build strength and sustainability in their businesses. He has a fierce commitment to delivering responsible and innovative risk solutions to all Noah’s Rule clients.
Since founding Noah’s Rule in 2004, he has been a hands-on, strategic advisor for the management of financial and commodity market risk and negotiations and oversight for hedging execution.
He has a strong track record in delivering excellent strategic risk advice to CEOs, company boards and senior management. His success at Noah’s Rule comes from formidable industry knowledge gained over more than 30 years in financial markets. His roles included Managing Director of Treasury at NM Rothschild and Sons (Australia).
A strong advocate for developing a high level of risk awareness in the business community, he takes pride in developing and fine tuning intelligent and responsive risk solutions for all Noah’s Rule clients.
Dave Rowe, Principal, Noah’s Rule. Using his in-depth expertise in financial markets, Dave is highly successful in identifying and managing key financial risks for Noah’s Rule clients. With over 30 years of industry experience, much of it in the development of treasury products, he possesses deep knowledge of precious and base metals, energy, agricultural and financial markets and is adept at reporting, pricing and trading risk across these markets.
Before joining Noah’s Rule, he held senior roles at NM Rothschild (Australia), National Mutual Royal Bank and Citicorp. At NM Rothschild and Sons (Australia) Limited he was a director and managed large trading and sales teams as Head of Trading and Head of Market Risk.
By gaining a perspective from ‘both sides of the business’ at Rothschild, he is well placed to offer critical insights for clients seeking to trade profitably and accurately report market risk.
This makes him an indispensable member of the Noah’s Rule team.
He has a Bachelor of Economics from Macquarie University and a Graduate Diploma in Theology from Morling Theological College.