Two hedgers get new look

Barrick Gold’s recent announcement that it will sell half its gold at spot rates didn’t take many by surprise, even though it had the same ring as an archbishop voicing doubts about the Resurrection. Coupled with the steady unwinding of hedge positions now being done by the industry’s other heavyweight hedger, AngloGold, Barrick’s change in policy suggests that much may be afoot in the gold market.

While AngloGold’s cuts to its book earlier in the year were part of a long-term reduction in hedge positions, Barrick’s move is more abrupt and suggests the company is sensitive to a swing in underlying market sentiment. The company that was built to last really wouldn’t be bearish to the last.

It is significant that Barrick, the company generally considered to be the gold industry’s most accomplished hedger, should be now halving its hedge book. It is more significant still that the company should be halving a hedge book that had widely been presented as being both virtually risk-free and capable of capturing any increase in gold’s spot price. If indeed the structure of Barrick’s hedge book meant that any upward move in the gold price was already in the bag, then why make any move at all?

There may be several explanations.

– Lease rates may be increasing. For a year or so now, many central banks have been taking delivery of some leased gold once the contracts that covered it have expired. This contrasts with their former practice of rolling leases over and continuing to earn interest. It is not often observed that for central bankers, gold is money to a far greater extent than it is even for gold producers. When central banks hold gold, they not unreasonably want to earn a return on it, and given their responsibilities as guardians of national currencies, they can only deal with solid counterparties. Gold leasing was born of that need.

If central banks are calling back leased gold, the implication would seem to be that they need the gold. The continuing rise of the U.S. dollar against almost all the world’s other currencies has almost certainly taken a toll on most central banks’ foreign currency reserves. When a major reserve currency goes on a bull run, the only way to arrest a slide in your own currency’s value against it is to buy your currency with that same reserve currency. To intervene by trading euros or yen instead will do little to stabilize the decline in your own currency.

If many central banks have drawn down their reserves of U.S. dollars, one obvious way to build up liquid reserves is to take back gold as leases fall due.

If that gold is to be held by central banks, it follows that much less will be available for lease, and rates should increase proportionately.

– Interest rates may be depressed for some time. The economic slowdown has brought short-term rates to levels not seen since the early 1960s. Gold producers that hedged through leasing arrangements, then invested the proceeds in short-term government debt, were guaranteed of a significant profit by the spread between gold lease rates and short-term interest on cash. That spread has narrowed significantly, and should lease rates rise, it may close or reverse.

– The price of gold — in U.S. dollar terms — may be on the move once more. While greenback-denominated gold prices have been stagnant, the price has risen significantly against most other currencies, including the other major reserve currencies, along with the greenback’s exchange rate. A very strong American dollar is ultimately against the interests of the United States, implying an ever-increasing trade deficit and economic stagnation. Consumer demand, fed by liquidity from the U.S. central bank, has staved this off for now, but U.S. economic growth won’t be sustained in a high-dollar hothouse. If the U.S. dollar begins to slide, as most interested parties, including the U.S. government, need it to, gold will snap sharply upward in U.S.-dollar terms. Even the most sophisticated hedge book won’t capture all the value in a major rally.

– Volatility in the gold market may be increasing. When volatile prices are on a downward trend, hedge books cushion volatility. When they are on an upward trend, hedge books mainly just cost money.

It would be foolish to suggest Barrick is abandoning its pro-hedging philosophy. Half its production will still be sold into contracts with average prices well above the current spot price; that alone represents more gold than some senior gold companies produce. Neither is AngloGold’s slow and steady repositioning a repudiation of its earlier strategy. Both seem to have made conservative, thoughtful moves. But both turned quicker than the ocean liners they might have been supposed to be.