With gold trading below many miners' cost of production, Forbes, Reuters, and The Wall Street Journal have picked an interesting moment in time to publish hedging-related articles. Each of them has raised the issue over the past month. A common theme was whether or not gold miners would cave into pressure from the banks and brokerages.
There's no replacement for experience
Most financial professionals and mining executives have many decades worth of industry experience. Almost all of them look great on paper and sound confident reciting prepared speeches. Having participated during many up and down cycles, they've practically seen everything the market has to throw at them at least once.
So how could nearly all of them have missed the two-year window of opportunity to hedge a percentage of gold production between $1,400 and $1,800?
I can't be certain, but I think the answer is that even the oldest and wisest of veterans get swept away with the excitement of a roaring bull market. Expecting prices to rise further and caving to the pressure (coming from some outside force), Barrick Gold (NYSE:GOLD), Newcrest Mining (OTC:NCMGY), and AngloGold Ashanti (NYSE:AU) all spent billions buying back gold hedges in 2009. Had each just taken smaller, more conservative bites of the hedging apple, shareholders wouldn't have paid so dearly. Apparently, the only thing some miners have learned from that prior episode is that hedging is bad.
Flailing to the opposite extreme, "no hedging policy" seemed like the smart thing to do, so that's what Barrick and others have done.
It doesn't make any sense, though; responsible hedging isn't an all or nothing activity.
Stop trying to time the market
Is there not at least a handful (among hundreds) of miners that hedge little bits here, here, and there from time to time? With all the decades of learned experience, can't finance and mining own up to the fact they can't time the market? If you have to sell production below market (because of a hedge) and aren't able to capture the fattest possible profit margin, that's what you do -- you've laid your hedging bed, now sleep in it.
Is that scenario not unlike the one most miners find themselves in today anyway, selling gold at market prices that are below cost?
Stating the obvious
Unless hedging is related to financing activities, hedging in small denominations (3%-5% of production at a time) is a rather unorthodox thing for the industry to do. Kind of strange, being that most finance guys and gals tend to have such strong opinions on diversification and dollar-cost averaging (and don't believe in market timing).
After the fact, financial folks revert back to sounding good on paper. Stating the obvious: "The act of hedging is a sign of balance sheet weakness," said portfolio manager Catherine Raw at BlackRock, the world's largest asset manager and a major gold investor.
How strong would those same balance sheets look now if just one quarter to half of any particular miner's future gold production had been locked in above $1,400?
There's just a $200 difference (14%) between $1,400 per ounce and today's prices, but when all-in cost of production is $1,300, it makes all the difference in the world.
Borrower servant to thy lender
When you're not profitable and need to raise money, or refinance existing bonds (the position many gold miners are in), who else but the big banks and brokerages can you call? He who writes the checks tends to makes the rules, so if hedging at or around cost of production needs to be done, that's what the board of directors will do. No worries, miners can always borrow some money to buy back the hedges later anyway.