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Hedging by gold miners fell to a decadal low in the quarter ended September, according to the latest quarterly Thomson Reuters GFMS Société Générale Global Hedge Book Analysis.
Globally, gold mining companies hedge their production in the derivatives market, usually in options, to lock earnings. When prices fall, hedging takes a knock. "At the end of September, the outstanding global hedge book was 2.94 million oz, the lowest since our quarterly series began in 2002," said the report.
Mines have either allowed hedges to mature as scheduled, or proactively to close contracts for a profit and use the proceeds to repay debt. "To date, fresh hedging in this lower price environment has remained comparatively modest," said Cameron Alexander, manager (precious metals demand), Asia, GFMS Thomson Reuters, responding to a Business Standard query on the hedging positions of mines.
Generally, gold producers/mines refrain from hedging when they feel prices will fall further. Foreseeing a scenario of price rise, they hedge. In the last phase of the bull run, many mines that had sold or hedged production cut their positions (dehedging), which raised prices further. However, due to a sudden crash in gold prices in April 2013 led to miners staying away from hedging when prices averaged $1,326/oz in the September quarter.
In subsequent months, prices corrected, putting pressure on many mines, as prices traded below mining costs for many. The GFMS global average gold mining cost, including corporate expenses, stands at $1,350/oz; even after considering write-downs, it stands at $1,200/oz.
According to the report, efforts to cut costs have begun across the sector. Producers have cut non-essential capital expenditure, put in place wage freezes, cut corporate overheads and, wherever possible, optimised mine plans for higher throughput and higher grade ore processing, leading to reduced mine lives. Further, some large multi-asset producers have divested some of their higher cost mines and begun mine closures. This will afford them a certain degree of flexibility in the current environment.
"If gold prices fall further, we believe this will lead to a growing willingness to hedge, and we, therefore, expect a return to net hedging this year, with larger-scale hedging activity in 2015 and 2016. There may be pressure from shareholders to protect revenue streams in a declining price environment," says Alexander.
The crisis in the mining sector isn't likely to end soon. The fact that mines cut production (to cut losses when prices are low and don't cover costs) could support prices, but that will depend on whether the fall in demand is lower than the fall in production.
Alexander said, "Mine supply is expected to edge lower this year, before decreasing more rapidly in 2015 and 2016. Through 2014, a number of new operations will largely compensate for scheduled decreases in output from ageing mines elsewhere, as well as the supply lost due to the small number of operations closed so far on account of unsustainably high costs. From 2015, we expect to see more widespread closures or suspensions, as declining gold prices cut more deeply into the cost curve for a sustained period."
