Diggers & Dealers: Aussie gold miners happily hedge

Most of the locally-listed Australian gold producers are well placed to deal with the recent strength in the Australian dollar, thanks in part to their use of gold sales’ hedging mechanisms, according to gold mining consultants Surbiton Associates.

In Australia, hedging has been used as a price protection or risk management tool by some of the local gold producers since it was first undertaken in late-1981.

While it has tended to go in and out of favour over the years, hedging in various forms has provided some means of coping with the extraordinary volatility of the Australian dollar: US dollar exchange rate, as well as the many ups and downs in the gold price.

“The world watches the US dollar gold price but it is the Australian dollar price that is significant locally,” Surbiton Associates director Sandra Close said.

“Production costs such as labour, energy and reagents, are largely in Australian dollars, so the margin between sales and costs is very important.”

Gold prices in Australian dollar terms were high in mid-2016, with the all-time record peaking at almost $A1840 an ounce in early July.

Since then, the Australian dollar exchange rate has strengthened while the US dollar gold price has fallen.

“The effect of this ‘double-whammy’ has been to trim Australian dollar gold prices by around $A250 per ounce,” Dr Close said.

“Given that there are means available to reduce the risk of such price reductions, many local producers currently have hedge books in place – uncertainty, especially with falling local gold prices, does tend to focus the mind.”

Dr Close said the term “hedge” or “hedging” refers to a range of different mechanisms, which are used in determining the price a mining company ultimately receives from its bullion bank for gold it is yet to produce.

“Hedging using forward sales mechanisms, of which there are many variations, basically sets the price of gold the producer will receive at a specified time in the future,” Dr Close said.

“The other major hedging method is options, whereby a producer enters into put and/or call options, which may or may not be exercised, depending on the gold price at the time of delivery.”

She added companies periodically add to their hedge book in order to replace closed out hedges and in practice, they then do their best to take advantage of periods of higher prices.

However, prudently, at any time only a portion of the expected production is hedged, using forwards and/or options, with the remainder of the output exposed to the spot price.

“Historically, the Australian listed gold producers have been the most enthusiastic hedgers,” Dr Close said. “By comparison, many of the world’s largest gold producers regard hedging as something to be avoided.”

Several of these companies say their shareholders want full exposure to the gold price and do not want them to hedge.

“If those shareholders really want full exposure to the gold price, perhaps they should invest in gold exchange traded funds,” Dr Close said.

“That way they would get full exposure to the gold price, without corporate management risks, operational risks and all of the other risks inherent in gold or metal production.”

“Hedging is not a magic bullet but for the local Australian producers who use it wisely, hedging has proved to be an effective price protection method,” Dr Close said. “It can reduce downside while still allowing upside, that’s good risk management.”

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