The recent announcement by
The comments attributed to Munk were not as aggressive as some of his counterparts’ have been, as they stopped short of detailing buy-back programs, which have been indicated by
Barrick has traditionally been a strong proponent of hedging, and Munk’s comments may be viewed as the final capitulation by a major gold hedger. He made it clear that, though he believed in the value of hedging as an important risk management instrument, many investors were against it, and the new investment money has broadly supported the un-hedged producers, which is reflected in Barrick’s relative under-performance compared with Newmont. It would therefore appear that Barrick has been encouraged to abstain, to reposition the company, which is dwarfed by Newmont’s US$19-billion market capitalization.
The future impact of producer buy-backs is already starting to ease as many of the largest hedge portfolios have already been restructured and downsized. Crucially, Barrick’s “new” stance will do little to reverse this trend; in fact, it reduces the likelihood of a repeat of the major hedge-book reductions in the third quarter of 2002 and the second quarter of 2003. In this short note, we analyse the chairman’s comments and their implications for the gold market.
On Nov. 21, Munk, who heads the world’s third-largest gold producer, announced that the company was no longer committed to hedging, and, in the process, appeared to be reversing comments he had made the previous day.
“For the next decade, we aren’t going to do any more hedging,” he said. “The commitment to hedging has gone. Hedging enabled us to strengthen our balance sheet. Today, we don’t need it.”
We believe the comments are much less positive for the gold market when compared with the April 2001 statement by AngloGold that “the company was ‘aggressively’ reducing its hedge book because it was more bullish on the gold price.”
On the issue of buying back previously committed forward sales, Munk did not make any firm commitment, saying instead: “We could well do some de-hedging. We haven’t done it yet, but we may consider it. Now we are cash-rich; we could de-hedge or not. We never have to roll over our hedge positions. We have the option to accelerate delivery. Our delivery obligations go out for a decade. For the next decade we won’t ever have to roll over contracts. For the next forty quarters we will never have to deliver an ounce of gold for less than the spot price.”
In other words, the Barrick hedge portfolio will not necessarily be bought back; rather, where possible, Barrick will deliver into maturing hedge positions, as it has done over the past two years. Delivering into a hedge portfolio is a passive action which, although it will have the effect of reducing the number of ounces of spot gold sales, is unlikely to be a price-driver. Clearly, buying back a forward sale is an aggressive and transparent market action, which tends to attract speculative interest and, as such, drives the gold price higher.
The dealer community’s response to the announcement was positive, with gold gaining US$4 per oz., to US$397.50 per oz., in the immediate aftermath of the statement. The rationale is that the market expects to see a reduced level of future gold production being sold into the market, and there is suspicion that other hedged gold producers will follow Barrick’s lead, though it is worth noting that this group is now relatively limited, with Placer Dome and AngloGold being the only major gold producers with muti-million-ounce hedge portfolios.
We, however, would urge caution in the aftermath of Munk’s comments. The gold price tends to increase when producer de-hedging combines with fund buying. The reduction of hedge portfolios is alone not sufficient to drive the gold price significantly higher; rather, it appears to be price-supportive. Fund activity has largely established the level of the gold price over the past two years, and funds have established long positions, which currently total a net 9.3 million oz. on the Comex. So while Munk’s comments may be construed as price-supportive, there must be doubts over how much additional fund or investment buying they will encourage.
The trigger for the funds’ establishing their long positions in the bullion market can largely be attributed to the prospect of a reduction in gold hedge portfolios after Newmont successfully challenged AngloGold’s bid for Normandy Mining in early 2001. These two companies had very different philosophies on managing commodity price risk, and Newmont played the “gold hedge card” (buying back forward-sales to enable greater leverage to a rising gold price) and secured shareholder support as a result. The subsequent consolidation in the gold mining sector has focused further attention on the different philosophies employed by gold companies, and speculators were quick to exploit the “structural” weakness of the enlarged hedge positions of merged companies at a time of rising gold prices, low interest rates, and global political instability. All of this is illustrated by the relative underperformance of the Barrick share price and that of other hedged producers (for example,
Although, there were several statements from Barrick representatives that indicated that the chairman’s comments were not planned, Munk has effectively clarified Barrick’s immediate gold sales policy. We believe that the statement was much less aggressive than some market participants had been anticipating, and suggests that although Barrick is not going to add to its “premium gold sales program” for the next 10 years, it is also unlikely to buy back the committed ounces in the gold market at current prices levels (US$407 per oz.).
The executive directors of Barrick should also be encouraged by AngloGold’s relative performance against
The impact of Munk’s comments on the gold market could be construed as mildly bearish in the short term as it now becomes somewhat more difficult to determine what the propellant for a further gold price rise will be. During the past two years the gold market has been buoyed by a stock market collapse, a trend reversal in the U.S. dollar, major terrorist incidents across the globe, a war in the volatile Middle East, and a structural split in one of the major global political alliances, and at a time when gold producers effectively bought 900 tonnes of their own production.
The gold market will have to start to focus on the demand for physical metal, which has fallen in most of the major markets, or on investment products like the World Gold Council’s Equity Gold product in order to sustain the price momentum. Although it is now believed that there will be a reduced supply of gold from Barrick over the next 10 years, if the company sticks to its self-imposed moratorium, there is a major long position held by macro hedge funds that historically have not been slow to change their directional strategies.
When added to the general reduction of forward sales portfolios over the past two years, the withdrawal of Barrick from the gold forward market over the next decade, as implied by Munk’s statements, will have a substantial impact on long-term lease rates.
— The opinions presented are the authors’ and do not necessarily represent those of the Barclays group. For access to all of Barclays’ economic, foreign-exchange and fixed-income research, go to the web site at barclayscapital.com. Queries may be submitted to kevin.norrish@barcap.com
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