NEW YORK (Commodity Online): Experts in bullion will always tell you that if you watch the hedging pattern of gold miners, you can predict which way the yellow metal prices will move. So, what is gold hedging? Gold hedging is when a gold producer contractually locks in a gold price to be paid in the future when their gold is produced, regardless of whether the gold price in the future is higher or lower than the agreed upon contractual gold price.
The original reason gold mines used gold hedging was to protect a portion of their cash flow in the event that the gold prices dropped without warning. This way they could still pay their operating expenses. Gold mines use to hedge 10% of their annual gold production. However, a few years ago some major gold mines have hedged as much as 300% of their annual gold production. Which is a very large bet that the price of gold is going to go down. If that bet turns out to be wrong and there is a rapid spike in the gold price they could actually go bankrupt. It seems many of the large gold mining companies are rapidly changing their bets by moving from gold hedging to gold de-hedging as they prepare for what lies ahead in this gold bull market.
According to GFMS, who claim to be the world's foremost precious metals consultancy, gold hedging slumped to a 10 year low of 1,779 tonnes in 2004.
And, the case in 2010 is entirely different. Gold miners nowadays don't even bother to hedge their produce. This year, there is still no sign of producers considering adding new gold hedges, although some are looking at more creative options to fund projects, such as gold-streaming agreements.
With prices at record levels, gold miners have been steadily reducing their forward sales for the most of the last decade, often in response in pressure from shareholders who want to see greater exposure to the market.
GFMS said in its Q4 Global Hedge Book Analysis that it has not observed a shift in the attitudes of producers towards hedging, and these views remain firmly in line with the anti-hedging sentiment of prospective gold equity investors.
However, GFMS expects at some point in the future, mining companies will adopt a more flexible approach towards the practice of hedging.
Alternatives like gold-stream agreements, such as those facilitated by the likes of Gold Wheaton, and the recent private placement of gold participating bonds closed by Atna Resources to raise finance for development of its Reward property are being considered by firms now.
Together with the hedging of by-product metals like silver and copper, these new options can eliminate the need for extensive gold hedging in many cases of project financing, GFMS said.
While there is no significant new gold hedging forecast, the rate of dehedging is also expected to slow, simply because of the reduced size of the remaining global hedge book.
During the fourth quarter of 2009, net producer dehedging amounted to four-million ounces, which left the global hedge book at just 7,58-million ounces at the end of the year.
The size of the global book at end-2009 was a mere 8% of its peak seen in 1999, when it stood at just under 100-million ounces.
With dehedging for the full-year 2009 recorded at 8,16-million ounces, and the outstanding book at end-December at only 7,58-million ounces, it is quite clear that the volume of ongoing dehedging will diminish again in 2010, for the third consecutive year.