Hedging is a necessary evil. Like many I'm not a big fan of it. I have seen a handful of mining companies go belly up due to their hedging strategies. Pasminco is the poster boy of hedging gone wrong. Over the last 20 years of investing in gold miners I have yet to see one that has significantly profited from their gold hedging (insurance) when the gold price plummeted post the 2012 high..
That is not even the evil part. The evil part happens in the futures market. It is incorrect to say that the paper gold conjured out of thin air has no backing. It actually does. Yes every Oz of Gold and Silver in the futures market is backed. It is mainly backed by gold promised by the many Gold Miners out of their future production with a very tiny portion of above ground component to satisfy instances of real good delivery. Instances of which are actually few and far in between as most will take the cash option upon paper gold maturity. All in all the current estimated ratio is:
This extra supply puts significant downward pressure on the gold price as it satisfies the demand in an instant. For every 1 oz of gold there is close to 120 Oz of paper gold is in existence via the financial systems Fractional Reserve Gold System.
It is the world that we currently live in. It's a vicious cycle. Goldminers need $ to develop mines, they get $ up front buy hedging, paper market supply increases and puts downward pressure on the gold price. The gold miner suffers from low gold price when they come into production.
There is a solution to the madness:
1. People need to expand their understanding of mechanisms of the gold market. What I explained above is just a small snippet of it.
2. Gold miners need to stop hedging and this can only happen via a co-operative structure. i.e. The cooperative mechanism needs to be put in place in the industry so that small miners and explorers are able to approach larger cashed up miners for capital. Hard to implement as miners justifiably treat each other as competition.
3. Checks and balances need to be put in place to those that participate on the futures market without any intention of good delivery. This game of hot potato will end in tears one day. JP Morgan Chase and a few others have taken delivery of bullion just in case there are increased instances of real good delivery. This has put the toothless government organisations at bay but we all know they only take action after the damage is done. Not prevent it...
4. If you want to own gold own it physically and if you own it physically make sure it is
Allocated and not Unallocated (ownership from a pool)
. Definitely not the paper form. Read the fine print. The counter party risk alone should scare the bejesus out of you.
It is not just hedging is it now. It is the trickle that forms a mighty river of smoke and mirrors in the gold market.
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