To Hedge or Not to Hedge; The Dilemma for Gold Mining Companies

Gold mining companies should continue with their no-hedging strategy.

Jul 13, 2014 at 2:03PM

A major Russian gold producer earlier this month entered into the gold mining industry's biggest hedging transaction in six years. According to analysts at Thomson Reuters GFMS, gold producers will return to net hedging this year for the first time after 2011. Hedging future production certainly has its benefits. It guarantees future cash flows, especially during a volatile period like the one seen in 2013 when gold prices fell nearly 30%. However, it also limits the upside potential for mining companies.

Miners return to hedging
Hedging future production was common in 1990s. However, the practice became less common when gold entered into a decade-long bull run. In fact, mining companies spent billions of dollars to unwind hedged positions when gold prices surged in the era of easy monetary policy. In 2009, Barrick Gold (NYSE:ABX) raised over $5 billion to unwind its hedge book in order to capitalize on rising gold prices. Since then, the company has maintained a no-hedge position, which is not surprising given that gold prices surged after 2009 as the Federal Reserve launched multiple bond purchase programs.

AngloGold Ashanti (NYSE:AU) spent $6 billion to unwind its hedged positions. The company said last year year that it has no plans to return to hedging even though gold prices tumbled.

Despite major miners' aversion to hedging, gold producers will return to net hedging this year. According to Thomson Reuters GFMS, this will be the first time since 2011 that the gold mining industry will return to net hedging. This will be possible mainly due to a recent hedging transaction from Russian producer Polyus Gold.

The Russian gold producer recently announced that it entered into contracts to sell more than 300,000 ounces of gold over a two-year period. While the hedged position will give the company certainty over future cash flows, it also means giving up any future upside potential. Indeed, that is the major dilemma for gold miners. Hedging guarantees future cash flows, however, it means miners cannot capitalize if gold prices surge.

To hedge or not to hedge
Selling future production at a fixed price certainly has its benefits, especially in volatile times. In 2013, when gold prices plunged, hedging would have certainly benefited the industry. Late last year, John Lawson Thornton, Chairman of the Barrick Board, said that he would consider hedging strategy. Thornton noted that given the characteristics of a commodity like gold, it makes sense to hedge. Thornton's views, however, are not surprising, given that he has a banking background. The gold mining industry and investors, though, generally are not very keen on hedging.

Hedging is in fact seen as a a sign of weakness by investors, especially when it comes to majors such as Goldcorp (NYSE:GG) and Barrick Gold. Indeed, hedging may make sense for smaller producers that do not have the resources to cope with volatile gold prices. For major miners, though, it may not be a good idea, especially in the present environment.

As I have noted in several articles here, gold prices have found a strong floor at around $1,200 an ounce. Most major miners have all-in sustaining costs well below this level currently. More importantly, costs are expected to fall further as miners continue with their cost-cutting measures.

Therefore, miners have a lot more certainty in the present environment. Also, they would miss out any future surge in gold prices if they sold future production at fixed prices. This was the very reason why miners spent billions of dollars to unwind their hedged positions a few years. I do not expect them to return to the practice. 

Do you know this energy tax "loophole"?
You already know record oil and natural gas production is changing the lives of millions of Americans. But what you probably haven't heard is that the IRS is encouraging investors to support our growing energy renaissance, offering you a tax loophole to invest in some of America's greatest energy companies. Take advantage of this profitable opportunity by grabbing your brand-new special report, "The IRS Is Daring You to Make This Investment Now!," and you'll learn about the simple strategy to take advantage of a little-known IRS rule. Don't miss out on advice that could help you cut taxes for decades to come. Click here to learn more.

Varun Chandan Arora has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers