Hedging In The Gold Miners

There are two ways to run a gold mining company. One respects the simple fact that it is producing money. It is not eager to trade its the money, it produces for government paper, legal tender laws be damned. It keeps its books in gold, and produces and trades to earn more money (i.e. gold).

This article is about the other kind, the conventional gold miner in our dollarized world. With its books in dollars, and more importantly its debt in dollars, it must generate positive cash flow in dollars. Or else.

It faces constant temptation (and shareholder pressure) to make a leveraged bet on the price of gold. If it wins, then its debts shrink in proportion. However, if it’s wrong and the gold price falls, it can be crushed into bankruptcy. Such is the nature of having a debt in a foreign currency when that currency rises. Even though the dollar falls over the long term, there can be wicked periods when it is rising such as 2012-present.

At the LBMA conference in Vienna, the most interesting panel for me was the one on Producer Hedging and Price Risk Management. In fact, to this last point, Courtney Lynn the Treasurer of Coeur Mining said miners have no special foreknowledge of the gold price.

Her company, and that of another panelist—Petropavlovsk—are in debt. How do you run a company with dollar denominated debt and net revenues that sink or swim based on the gold price?

You hedge the price of gold.

So it’s interesting there has been an epic decline in hedging by the gold miners. Across the sector, the total forward sales of the industry used to be a year worth of production. Now it is three weeks, a drop of almost 95%. One theory is that this is related to the price. But I don’t buy that.

One panelist (if I recall correctly, it was Sean Russo of Noah’s Rule in Australia) noted that the gold basis—the higher price of a futures contract relative to spot—has collapsed. He said this is important because if you’re thinking of selling forward and you can earn a big 10% premium to sell a few years out, it mitigates the fear of missing out in a big price rally. Is the gold price really expected to rise more than 10% in two years?