Hedge books present problems for few gold miners

Despite the public difficulties faced by gold producers Ashanti Goldfields (ASL-N) and Cambior (CBJ-T), a recent analysis of gold producers’ hedge positions shows that most are not facing large losses in their hedge programs.

Analysts Roger Chaplin, Michael Jones and Rhona O’Connell of London-based T. Hoare Canaccord examined the companies’ announced hedge positions. They concluded that only Ashanti and Cambior were immediately vulnerable to hedge-book losses: those companies had sold significant blocks of calls committing them to deliver more gold than could be provided by the company’s own production.

The T. Hoare analysts suggest that Australian producers, most of which are generally known as active hedgers, had structured their hedge books using bought put options that would allow them to sell substantial production if the price fell, while still allowing them to sell into the spot market if those options were out of the money.

The hedging issue was a strong element in the past week’s volatility in the gold market, which began when Placer Dome (PDG-T) announced it would no longer add new hedge positions. The effect of this move would be to take 2 million oz. out of Placer Dome’s hedge book by the end of 2000.

Placer Dome had contracted substantial forward sales in the last months of 1999, when the announcement that European central banks had agreed to cap their gold sales for a 5-year period briefly elevated gold prices above US$330 per oz. By the end of December, Placer Dome had 7.4 million oz. sold forward, and a further 2.5 million oz. in call options.

Placer Dome’s announcement, on Feb. 4, first created a spike in the gold price, as traders anticipated that strong upside moves would no longer be dampened by producer sales. Profit-taking on Feb. 5 brought the price back down below US$300, but speculation continued that other major producers might follow Placer Dome’s lead.

Among the producers at the centre of rumour were Anglogold (AU-N), whose quarterly results were due on Feb. 10, and Barrick Gold (ABX-T), whose hedging program has long been the envy of the gold industry. Barrick cut its net hedge position to 9.8 million oz. from 18.8 million in late 1999.

Barrick’s president, Randall Oliphant, told investors at a Montreal road show that the company has no plans to increase the size of its commitment in spot-deferred contracts, the traditional backbone of Barrick’s hedging strategy. At year-end, the company had spot-deferred contracts for 13.6 million oz. at US$360 per oz., stretching out past 2006, and had sold call options on a further 3 million oz. Against that, Barrick bought calls on 6.8 million oz. at average strike prices of US$319 in 2000 and US$335 in 2001.

The bought calls can be exercised at Barrick’s option; if gold moves above US$360 per oz., the floor price established by the spot-deferred contracts, the company will exercise the calls and receive the difference between the spot and strike prices.

Agnico-Eagle Mines (AGE-T) reaffirmed its position as a committed spot seller this week, drawing some comfort from Placer Dome’s change in strategy. Agnico, and similar smaller producers, have historically been lighter hedgers, and their stock prices have been more sensitive to changes in the gold price.

T. Hoare’s analysts ascribed Ashanti’s and Cambior’s hedging problems to having sold unprotected call options. The sudden price increases last October found both producers’ hedge books on the wrong side of the market.

Ashanti had sold calls to finance purchases of put options, and gold’s October spike brought the spot price close to the strike price of the calls. This triggered margin calls in the option contracts, and Ashanti simply did not have the cash on-hand to meet them. At the time, the hedge book had a negative value of around US$450 million if all options were exercised.

The T. Hoare analysts note that Ashanti has made sweeping changes to its hedge book since October, and submitted financial and operating plans to its lenders under which the lenders’ rights to make margin calls are largely suspended until 2002; in return, the lenders get convertible debentures that could give them about 15% of Ashanti’s outstanding shares. The restructuring is complicated by Ashanti’s debt under existing loan agreements and its need for financing for the Geita project in Tanzania. Ashanti is shopping an interest in Geita around as a possible source of immediate cash, which could make the restructuring easier to sell to its lenders.

Cambior’s hedge book had relied partly on sales of calls on more than 900,000 oz., deliverable in 1999. Restructuring that hedge, which cost the company an accounting loss of US$33 million, left Cambior with a book that had a negative paper value of US$47.4 million but could have realized a profit of US$40 million as long as the calls were not exercised.

Cambior recommended that shareholders reject a takeover bid by Aur Resources (AUR-T), launched in response to Cambior’s low share price and hedging woes (see separate story, page 11). The company had been planning the sale of its base metal assets, or alternatively its gold assets, to cover the immediate financial crunch.

The T. Hoare Cannacord analysis shows that most Canadian and U.S. producers have structured their hedge books to avoid price risk. TVX Gold (TVX-T), for example, has about 1.1 million oz. in put options, providing a simple floor for its gold revenues. Battle Mountain Gold (BMC-T) had bought puts and sold an equivalent number of calls to provide both a floor and a ceiling price for slightly less than half of its annual production.

Unhedged producers

The essentially unhedged producers among the North American majors include Kinross Gold (K-T), Echo Bay Mines (ECO-T), Homestake Mining (HM-N) and Newmont Mining (NEM-T). The first three have some forward sales or options, but these represent small fractions of their production.

Newmont’s brief foray into gold hedging came at the worst possible time, as it bought put options for just over 2 million oz. in 1999 as gold reached prices not seen since 1979. It balanced the puts with long-term call options with average strike prices of US$378. Its 1.2 million remaining puts, at US$270, are currently out of the money, but there is no loss waiting to happen in the small hedge book.

Newmont’s other participation in the hedge market consists of a small hedge position on production from its Minahasa project in Indonesia, and a forward sale of 483,333 oz. deliverable between 2005 and 2007.

African producers

The South African producers, traditionally the most conservative hedgers among the large gold producers, have largely stuck to fixed forward contracts to ensure a fixed price on part of their production. Both Gold Fields (GOLD-Q) and Harmony Gold Mining (HGMCY-Q) do not hedge as a matter of company policy, though Gold Fields has a small portfolio tied specifically to its Tarkwa, Oryx and Beatrix mines. Randfontein Estates, recently taken over by Harmony, had a relatively large hedge portfolio, including call options it had sold for 1.1 million oz.

Anglogold, which has used mainly fixed forward sales, has a maximum of 40% of its production committed to these sales in 2000, and generally less in later years.

The aggressive hedging of the major Australian producers, which might have been expected to produce one or two Ashantis or Cambiors, in fact was largely insulated from sudden price increases. Newcrest Mining has the largest position on its books, about 10.5 million oz., which represents more than 12 years of production. Normandy Mining (NDY-T), with about 9.7 million oz. in contracts, comes in second, but the book represents under six years of production and is structured largely in forward sales and put options.

The Australian producers seen as most likely to benefit from a higher gold price are Sons of Gwalia and Resolute. Sons of Gwalia has structured its hedge book almost entirely around put options, allowing it to let the options lapse should spot prices rise past the strike price of the puts.

Resolute, with a total hedge position of 740,000 oz., could see a crunch in 2000, as its current forward sales exceed its expected annual production of 300,000 oz. Some of those forward sales are in spot-deferred contracts that could be rolled over. A project hedge for Resolute’s Golden Pride project in Tanzania carries a possible margin call should its book value fall below a negative US$30 million; that is the only significant risk for Resolute.