Over the hedge: Gold pricing and hedging

Traditionally hedging has been a last resort, particularly in gold mining which hasn't had a healthy relationship with the activity. 
Locking in gold production can potentially limit profits and if the commoditiy experiences unexpected surges (which it can tend to do) it can prove to be an anchor on profits. 
Asking analysts to predict the long term gold price is like asking meteorologists to predict the long range weather forecast, they all come up with different answers, which they all back up with different reasons.  
At the 2013 Diggers and Dealers forum in Kalgoorlie, the bullish World Gold Council, which is an industry funded body, predicted the resources super cycle is not over, saying the recent price drops are nothing but a short term readjustment. 
World Gold Council managing director of investment Marcus Grubb explained gold demand is driven by wealth, demographics, savings rates, weddings and festivals and will continue to grow as Indian and Chinese wealth increases. 
"We don't believe in a long term bear market for gold," Grubb said. 
The gold bears say April's gold price drop is just the beginning, predicting the bullion market to continue to plummet to around $900 an ounce, a figure that would render much of Australia's gold mines unviable. 
Emerging gold producer Northern Star Resources managing director Bill Beament bucked the trend of downbeat gold miners at the Diggers and Dealers conference, saying the gold price is "fantastic", telling Australian Mining "two years ago we were jumping around in Kalgoorlie here singing its praises, and it's the same price". 
But as is the cyclical nature of the resources sector, hedging is the new black, quietly shuffling its way back into producers' strategies. 
With uncertainty rife in the gold sector it is tempting to lock in gold prices as insurance, just in case the bears are right. Especially for juniors and mid tier miners attempting to raise capital, financiers – including the big banks, are more likely to hand over the dollars if there is an insurance policy of sorts and stable cash flows are in place. 
But hedging is a defensive mechanism and can prove to be an anchor if the gold bulls are on the money. 
A recent J.P. Morgan Chase study reports 61 per cent of investors are against miners hedging gold prices. Investors generally prefer to hold gold company shares with full exposure to any potential rise in gold prices. 
Moving to hedge gold production now can potentially send a signal to the market that the miner expects further commodity price drops, and add momentum to gold's decline. 
April's gold price drop has brought hedging back into the forefront of many junior's minds with some already locking in commodity hedging as insurance against volatile commodity prices. 
In August WA gold miner Doray Minerals delivered its first 144 ounce bar from the company's Andy Well gold project located new Meekatharra in Western Australia. 
Doray managed to secure $55 million in debt funding from the Commonwealth Bank last year for project infrastructure development and raised an additional $43 million in equity to cover mining and operational costs. 
Managing director Allan Kelly told Australian Mining if the company attempted to raise funding now it would've been "very difficult, probably impossible, our timing was good". 
Launching a gold mining operation in the midst of a weaker bullion market, Doray locked in about half of its gold production or 45,000 ounces for the first 15 months at $1620 an ounce. 
"We knew we would potentially need a lot of debt for the project so we decided to put some hedging in place as insurance against the project," Kelly said. 
Simon Tonkin, a senior resources analyst at Australian stockbroking firm Patersons agrees, explaining more than 90 per cent of development companies are struggling to raise the capital necessary to get projects into production. 
"Commodity prices are depressed and liquidity of funds has also dried up," he stated. 
Tonkin said many miners are "now looking to build smaller scale projects so these capital requirements are lower and more fundable". 
When it comes to hedging production Tonkin said prices are relatively low meaning producers are erring away from the idea. 
"For the lucky few that are in the position of looking to raise capital to build their projects hedging depends on the quality of the asset," he said. Launching into production at its DeGrussa copper mine, Sandfire Resources is one mid tier miner that was able to raise capital without hedging future production. 
Sirius Resources is another junior with a high grade asset, which Tonkin said probably won't require hedging. 
There appears to be a trend here – the higher quality the asset, the less likely financiers will stipulate hedging is required. 
"For those companies with average projects then yes hedging will probably be required," Tonkin stated. 
He explained financiers tend to require a portion (usually around 30 per cent) of production to be hedged, with the rest at spot price.  
"After all the financiers would like their money back," Tonkin stated. 
"Part of the issue with hedging is that if you hedge and then prices increase then costs can follow and there can be a margin squeeze. 
In 2009 investor's confidence was given a significant boos when the world's largest gold miner Barrick Gold announced it would unwind its remaining hedges. 
"We saw most gold companies unwind all hedging in the mid-2000s."

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