Hedging loses its lustre for gold - Incentive for forward sales has gone as prices soar

Hedging loses its lustre for gold - Incentive for forward sales has gone as prices soar
By Javier Blas in London
Copyright The Financial Times Limited 2009
Published: September 13 2009 19:26 | Last updated: September 13 2009 19:26
http://www.ft.com/cms/s/0/3756f6ac-a08f-11de-b9ef-00144feabdc0.html


The gold industry’s legacy of forward sales is set to all but disappear by next year following the decision by the largest gold miner to buy back its hedges.

The size of the industry’s hedge book is set to drop to a residual of less than 200 tonnes by the end of 2010, the lowest in almost 25 years, according to industry estimates.

The reduction is a 95 per cent drop from 3,000 tonnes a decade ago.

The mining hedge book is important for gold prices. Bullion rose above $1,000 a troy ounce last week as investors sought refuge from dollar weakness.

When miners sell forward their production, they help push down prices. In 1999, their hedge book blew up to more than a year of mine output, flooding the market. Buying back the hedges since then has contributed to higher gold prices. As miners complete the buying back by late 2010, the hedge book will be a neutral force.

Miners sold forward their production to ensure a floor price, secure a stable cash flow and raise finance. But as gold prices have steadily increased from $250 in 1999 to more than $1,000 an ounce last week, the incentive has gone.

Barrick Gold, the Canadian-based miner, said last week that it would spend $2.9bn to buy back most of its hedge book, leaving AngloGold Ashanti, the third largest gold miner, as the only remaining top miner with significant forward sales.

Consultants and bankers believe the hedge book is unlikely to drop further beyond 150-200 tonnes because a residual amount of forward selling would be necessary for some miners to raise finance for projects.

John Reade, precious metals strategist at UBS in London, said Barrick’s move, “like the bell that rings as cyclists start their final lap, marks the beginning of the end of the global gold miner hedge book”.

Barrick said it had decided to buy back its forward sales because of “an increasingly positive outlook on the gold price”. It added: “Global monetary and fiscal reflation will be necessary for years to come, resulting in an increased risk of higher inflation and a future negative impact on the value of global currencies.”

Mr Reade said that once Barrick’s buy-back was completed it “will place increasing pressure on AngloGold to follow suit”.