With so many myths about gold still dissuading many investors from gaining exposure to the time-tested monetary metal, I have no intention of letting a new myth take hold.
A barrage of articles crossed the financial newswires Monday, attempting to portray increased gold hedging activity as an indication of miners' cooling outlooks on gold prices. Please join me in promptly burying that gross misperception before it becomes yet another unfounded rationale by which investors might steer clear of gold.
For a moment there, I thought I was going to have to rebut several articles on the topic. But as it turns out, Monday's gold sector headlines were infiltrated by multiple iterations of essentially the same promotional content packaged under different headlines. This one proclaimed that miners are taking "a more conservative stance toward gold prices," while peddling some reports on Yamana Gold
The IBTimes posted a separate (but equally egregious) misinterpretation of gold hedging data on Friday, stating: "[A] growing number of gold mining companies seem to have become more cautious again in the second quarter of this year by hedging their future output against rising price fluctuations." In truth, however, the reported second-quarter increase in the global hedge book was miniscule in scale, and was undertaken by a very few junior resource companies for specific reasons that had nothing whatsoever to do with a "more cautious" outlook on gold prices.
Keeping the numbers in context
According to Thomson Reuters GFMS, the global hedge book for gold grew by 190,000 ounces, to 5.07 million ounces. That reported increase amounts to less than one-quarter of 1% of global gold production for 2010 (78.4 million ounces). Relative to total mine production for the second quarter of 2011, the reported increase still represents just 0.8%! Furthermore, taken in the context of a 95% reduction in the global hedge book from more than 100 million ounces over the past decade, a sequential increase of the sort hardly budges the needle. In other words, the miniscule rise is scarcely newsworthy, and miles away from being indicative of any shift in sentiment.
The authors of the underlying report could not have been clearer. They stated flat-out: "[It] would be wrong to assume ... that general attitudes to hedging among the major gold mining companies have changed." Only two years ago, the world's dominant producer -- Barrick Gold
As a further caution against making too much of that small sequential rise, it's worth noting that another reliable industry source actually reported a reduction in the global hedge book for the second quarter of 2011. Metals consultancy VM Group, in coordination with ABN AMRO Bank, in August issued this report [opens PDF], which logged a 900,000-ounce contraction of the hedge book to reach 4.2 million ounces. The following chart from that report places the latest data within its proper context, and visually refutes any notion that miners are reversing their collective stance toward strategic gold hedges.
Source: VM Group; ABN AMRO Gold Hedging Report, August 2011.
What these gold hedges really reflect
Even if we were to adopt the GFMS data, including their forecast that the hedge book may expand by 1 million ounces during 2011, that still would not reflect a shift in sentiment toward forward gold prices. You see, the new gold hedges identified by GFMS during the second quarter were not born of a bearish outlook toward gold. To the contrary, bullish industry sentiment continues to fuel a race among junior miners to accelerate development timelines, and many are forced to rely upon bank debt to finance mine construction.
As a matter of course, banks routinely require miners to hedge a portion of forward production as a condition of debt issuance. According to George Gero, senior vice president for RBC Capital Markets Global Futures, "Junior miners have to hedge because they have to show the bank they have this much in production and this much in future sales, or they don't get the financing." Examining the two principal new hedges detailed by GFMS in its report, we find that both arrangements by a pair of Australian junior miners were indeed linked to debt facilities for financing mine construction.
As we have established above, the increase in the global hedge book reported by GFMS is truly miniscule in relative scale, and is furthermore contradicted by another professional assessment that reported a decline in net gold hedges nearly five times as large. What's more, because these new hedges are a precondition for access to needed development capital -- and not a product of strategic speculation of forward gold prices -- it is incorrect and improper to suggest that these hedges reflect any shift whatsoever in the outlook of gold mining executives toward the ongoing bull market.
GFMS itself made that point abundantly clear, but even that did not prevent a barrage of potentially misleading discussion from crossing the financial newswires. With this rebuttal, I hope to have corrected their collective error, and interrupted the process by which ill-informed analysis can transform into prevalent and unfortunate myths.
What the miners really expect
Now that we have established what is not true about miners' outlooks toward gold prices, let's review what we do know. We know that Newmont Mining
I share their bullish outlook on gold, and anticipate powerful upside momentum for many quality gold producers over the coming years. I've identified a number of exciting prospects within the industry for my regular readers, and I invite you to keep track of my ongoing analysis by bookmarking my list of recent articles here. To get started, find out why I believe Primero Mining