Gold Miners Don't Think Price Will Fall, Hedging Still Isolated

December 18, 2014

But gold miner industry 'fundamentally unhealthy' as 2014 price drop hits 60 percent of output.


This article originally appeared on BullionVault and is republished here with permission.

Gold miners are still not hedging their future production despite the recent price-drop to new 4.5-year lows, says the latest expert analysis, as zero interest rates and falling energy prices are deterring forward sales to lock in current prices.

"There is not yet compelling evidence to indicate an extended rise in the volume of hedging by gold miners," says Matthew Piggott, senior precious metals analyst at Thomson Reuters GFMS, introducing the consultancy's Q3 2014 report for French investment bank and bullion market maker Societe Generale on Tuesday.

Growing 57 tonnes by weight in the first nine months of 2014, the global gold mining hedge book—the amount of unmined production effectively sold in advance to lock in prices—fell between July and October, says GFMS, dropping some 6 tonnes as new output was delivered to meet existing contracts.

Totaling some 148 tonnes by end-September, however, the gold mining industry's unrealized short position rose by value thanks to the drop in gold prices, reaching $440 million equally split between forward sales and options contracts, which give a miner the ability to sell gold at a pre-agreed level should prices fall.

This autumn's sharp drop in crude oil prices, notes consultancy Metals Focus meantime, should reduce gold mining cash costs for some producers, with the world’s No.1 producer Barrick (NYSE:ABX) saving perhaps $25 per ounce on lower diesel expenses.

But margins remain under pressure, Metals Focus says, and total cash costs have "remained broadly level for the past five quarters", averaging $733 per ounce across the industry worldwide despite lower input prices and the lower market-price of gold.

The 2014 drop in gold's average price, now down 10 percent from 2013, means "the mining industry is in a fundamentally unhealthy state," GFMS' report goes, "with projects shelved, exploration expenditure cut back and sustaining capital being thrifted or deferred where possible."

While GFMS says "these effects will become more severe" if gold prices drop to $1,100 per ounce—putting some 60 percent of the industry underwater on its analysis of "all-in" costs—today's low interest rates, plus memories of the huge overhedging seen in the late 1990s, are deterring management from protecting against further falls.

Low rates mean there is no "attractive premium" to current prices offered by forwards rates—the price-curve calculated from storage and interest charges on future deliveries of gold, known as "contango".

"To hedge in the absence of premium [would] signify that a producer believes the price will fall," says Piggott at GFMS. So "while we may see some isolated instances of companies entering into [hedging] positions, we maintain our view that conditions in the market are not yet aligned for a return to producer hedging en masse."

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