Trimming the hedge

Facts ‘N’ Figures

Resurgent de-hedging gained momentum in the first quarter of 2006, with a provisional 4.6 million oz. (142 tonnes) chopped from outstanding contracts, which left the global hedge book at the end of March totalling 50.3 million oz. (1,563 tonnes), according to Global Hedge Book Analysis Q1, 2006, recently published by London-based consultant, GFMS.

The reduction represented the largest quarterly fall since the fourth quarter of 2002, and was in strong contrast with the fourth quarter of 2005.

In addition, the corresponding period of 2005 de-hedging was also comparatively small, at 700,000 oz. (22 tonnes), representing a six-fold increase year-on-year.

Most significant was Barrick Gold’s restructuring of its hedge book in the wake of the acquisition of Placer Dome. As a result, the corporation’s de-hedging activities constituted 80% of the net reduction for the quarter. Inextricably linked to this, the forward contracts portion of the global book saw the most sizable contraction in volume terms, amounting to 4.4 million oz. (136 tonnes). Non-vanilla options also saw a considerable reduction in percentage terms, having been cut by 85%. In contrast, vanilla options (an ordinary put or call) were up by 2%, partly due to an increase to the delta net call position.

The gold price at the end of the quarter (used to value the options contracts) stood at US$582 per oz., representing a significant rise of US$69 per oz. This increase was reflected in the implied delta of the net vanilla options book, which increased by close to 4% quarter-on-quarter.

Notably, despite the significant cut recorded to the global book, the higher gold price deteriorated the industry marked-to-market book value by a whopping 37% quarter-on-quarter, to a negative US$10.6 billion. Broadly speaking, as a paper loss the marked-to-market shortfall is less dramatic than it may seem, although for Australian-listed companies, a recently implemented change by the Australian Equivalents of International Composition of the Delta-Adjusted Global Hedge Book Financial Reporting Standards (AIFRS) requires that marked-to-market adjustments be included in the quarterly balance sheet. In a similar vein, but on the positive side for producers, the average realized gold price for the quarter rose by a remarkable US$75 per oz. to US$533 per oz., a shortfall of US$21 per oz. against the average London spot price, compared with a US$26 per oz. average shortfall in the previous quarter.

Gold’s dramatic rally

Gold’s dramatic rally continued in the first quarter, with an intra-period gain of US$52 per oz. On the basis of the London p.m. fix, a price low of US$524.75 per oz. was noted on Jan. 5, the third trading day of the New Year, with the high for the quarter (as well as for the past 24 years), of US$584 per oz. on March 30, before dipping by US$2 to end the quarter at US$582 per oz., having averaged US$554.07 per oz. over the three months. This compared with an end-of-fourth-quarter price of US$513 per oz. and a fourth-quarter average of US$484.20 per oz.

Gold investment demand was yet again one of the prime drivers of the price rally the metal enjoyed throughout the first quarter of 2006 and into the second quarter. The price performance of the yellow metal over the last few months of 2005 and the breach of the US$500-mark in December in particular, meant that investor sentiment at the beginning of 2006 was very positive. Expectations of a weakening U.S. dollar, which to some extent has recently been proven correct, are also understood to have attracted investors to the metal.