GOLD ANALYSIS

Gold producer hedge book is at its lowest since 1992

Major gold miners have continued to reduce their hedge positions during 2007 with the total book now at its lowest for 16 years.

LONDON - 

Société Générale's latest analysis of the global gold mine producer hedge book, compiled by GFMS Ltd, concludes that the hedge book stands at just 835 tonnes, which is the lowest level since 1992, and is equivalent to 34% of 2007 production levels.  De-hedging in the fourth quarter was 72 tonnes.  For the year as a whole, dehedging in 2007 was a record at 446 tonnes, which meant that mine supply last year was 2,030 tonnes, compared with 2,076 tonnes in 2006.  Despite the reduction in the volume of the book, price movements mean that the marked-to market value of the combined book deteriorated to negative $9.4 billion, while producers' average realised prices increased by 15% in US dollar term to $767/ounce, compared with an average spot gold price of $786.25/ounce. 

Over the year as a whole, some two-thirds of dehedging took place in the first half of the year, with just 16% of the annual figures attributable to events in the fourth quarter, driven by a small number of producers.  The study makes the point that there was a "conspicuous" lack of fresh hedging during the quarter, with the most substantial addition to nominal contract volumes coming from a 14,000-ounce (0.45 tonnes) addition to existing hedge contracts by Equigold.

The top de-hedgers in the quarter were Newcrest Mining, with a decline of 0.73 million ounces (22.7 tonnes) or 31%, followed by Red Back Mining with 0.25 million ounces (7.8 tonnes) and Highlands Pacific, with 0.24 million ounces (7.5 tonnes).  Newcrest eliminated the last of its Australian dollar-denominated Gold Bullion Sales Contracts, amounting to 0.51 million ounces in October and then removing 0.23 million ounces of its US dollar denominated Gold Bullion Sales Contracts.  As of 31^st December 2007, Newcrest did not have any deliveries due before 2012.

Red Back Mining is now hedge-free, having closed out the remaining hedges against its Chirano property in Ghana.  This was effected though the repurchase of the remaining 0.25 million ounces, financed through a $110 million fully underwritten share offering at the end of October.  Highlands Pacific closed out its project loan facility and the entire remaining hedging programme relating to its Kainantu mine when the company completed the sale of the project to Barrick.

Barrick itself reduced its hedge book by 0.2 million ounces through the conversion of fixed price forward contracts to floating price products.  The terms of the floating price spot sales suggest that the contracts may, at the crystallised deduction to the spot price, be converted back into a fixed price product up to the point of maturity, which in many cases is as far forward as 2019.

AngloGold Ashanti, meanwhile, the company with the largest book, has continued its active management of the position in order to maximise value from the existing contracts.  As a result, despite the increase in the gold price through to the end of the quarter, the net delta position was reduced from 10.58 million ounces to 10.39 million ounces, stemming largely from a hefty cut in the company's sold call position.

AngloGold Ashanti's book, at 10.39 million ounces, thus constitutes 39% of the global total, with Barrick accounting approximately for a further 30%

The overall book at the end of December comprised 18.26 million ounces (568 tonnes) of forwards and gold loans, with 8.60 million ounces (267 tonnes) of delta-adjusted options positions.  On a nominal basis the book was 32.39 million ounces or 1,007 tonnes, with the nominal volume of the option contracts standing at 14.13 million ounces or 440 tonnes.

The price sensitivity of the book has been reduced, which may seem counter-intuitive given the increase in the gold price.  The reduction comes from the fact that many sold call positions are deeply in the money and already carrying a delta of almost 1 and that the exposure of bought puts decreases as the price increases, since, pari passu, the probability of their exercise is reduced under a higher price.  The study shows a matrix of the price-sensitivity of the end-quarter option positions to step movements in prices, using the management software from Brady Trinity^TM, the technical company that models all the individual changes in miners' hedge books.  This shows how the delta position would change against shifts in the gold price and in volatility and calculates, just as one example, that a $100 drop in gold and a 4% increase in volatility would reduce the delta-adjusted options book from 8.60 million ounces 27 tonnes) to 8.27 million ounces or 257 tonnes.

Since the end of 2007, there have been further significant position closures, including Buenaventura's closure of its outstanding position through the closure of a four tonne forward position (that had been due in 2010), followed by the closure of the remaining outstanding 24 tonnes that had been due for delivery between 2010 and 2012.  Buenaventura is therefore now hedge-free.

The delivery profile looking forwards suggests potential dehedging of just over five million ounces or 156 tonnes in 2008, dropping to roughly 4.2 million ounces or 131 tonnes) in 2009 and a further reduction in 2010, before a slight increase in 2011, albeit to less than five million ounces.  Both Barrick and AngloGold Ashanti have suggested that they will be reducing their books gradually though a combination of active management and deliveries in order to maximise the value that can be gained from outstanding positions.  The study also notes that with the current high gold price and the difficulties in the credit market, companies without a strong balance sheet may find it difficult to obtain large lines of credit in the near future.

These factors point to a slowing in hedge buy-backs this year over and above the existing delivery schedule.