...this article underscores why gold stocks have underperformed...

...this article underscores why gold stocks have underperformed gold, the three factors - hedging/production/AISC and explains why I am less enthusiastic about gold producers relative to Gold.
....the time has not yet arrived for gold juniors to really shine. Because at least gold exploration juniors have no such worry.
Why investors are sick of gold miners hedging
Elouise FowlerReporter
Apr 23, 2023 – 1.27pm


China, Russia and Turkey bought vast amounts of gold via their central banks over the past year to bolster their foreign exchange reserves and diversify against the world’s most popular currency, the US dollar.

Demand for gold jewellery in China has rebounded since lockdowns ended there. And fearful investors seeking safety from the global banking crisis have pumped money into physical gold exchange-traded funds, lifting ETF inflows in March for the first time in 10 months.
These drivers all suggest demand for gold will remain strong, says David Franklyn, managing partner of Perth-based fund Argonaut Resources.
“If you take a long-term view, the world is changing. I reckon we’ve entered an era of increased political risks,” Franklyn tells The Australian Financial Review. “So, I think gold – as a store of value and as a hedge against uncertainty – is coming back.”

If Franklyn is right, why would gold miners choose to lock in prices with multi-year hedging agreements? It’s a temptation that other fund managers, such as David Baker, the managing partner of Baker Steel, urge them to resist.

Gold has rallied 10 per cent this year and soft US economic data pushed the gold price to $US2002 ($2991) an ounce on Friday, close to its one-year high.

Investors, fuelled by their conviction that the rally has further to run as tumult ripples through global markets, are seeking clean exposure to the precious metal, unencumbered by hedges struck when the gold price was lower.

“What I look for is companies that have zero or moderate levels of hedging, because we’re looking for pure gold exposure,” says Franklyn, who established a gold fund in November because he thought the sector was undervalued.
Baker agrees: “If history is anything to go by, I would argue that for the majority of miners that hedging has cost shareholders in terms of lost revenue.”

The call to resist locking in long-term hedges has been met with strong resistance from advisers and gold executives, who defend Australian miners missing out on at least $200 an ounce, and up to $1400 an ounce, of profit because of hedges decided years ago.

Noah’s Rule managing director Sean Russo, who advises gold miners on hedging, says it should be used to deliver a degree of certainty to a business managing debt or dividend payments, and not to punt on the trajectory of future prices.

“You can say ‘the world’s changed, the world’s falling apart’... or whatever argument you have for much higher gold prices,” Russo says. “But the idea that a highly capital-intensive business can blithely say, ‘I don’t think there’s a chance the gold price can [drop] back to where it was four years ago’ is a big risk. That’s a risk that some companies are not willing to take. Hedging gives them some level of control over cashflow and planning.”
‘The worst hedge’

Indeed, pure exposure to the gold price is difficult to find within ASX gold miners.

Hedging was deeply unfashionable around the turn of the century because it locked several big miners out of gold’s 10-year rise from $US250 per ounce in 2001 to $US1900 per ounce in 2011.
But many Australian miners resumed hedging around 2013, when gold suddenly lost about 30 per cent of its value in the winter of that year.

Regis Resources is viewed as a cautionary tale. Hedges struck several years ago by previous management mean the company is losing up to $200 million, says Dan Morgan, an analyst with broker Barrenjoey.

“Regis does have the worst hedge,” Morgan says. “On my numbers, it’s a $200 million loss against what they could get if they were delivering into spot.”

Regis has to sell 170,000 ounces of gold at $1571 an ounce when the gold spot price is almost double that, all while the cost of producing the precious metal has increased to $1800 an ounce because of inflation.

“I wouldn’t criticise management on it, they are dealing with it, they are delivering into it. And so you might say that their financial results or earnings for the next year and a half are going to suffer,” Morgan says.

But Baker, who holds 8 per cent of the company, urges Regis to use its $67 million tax windfall to start buying back its hedges to regain exposure to the spot price, a move made famous by Newcrest in the 1990s.
Newcrest’s flagship Cadia gold mine near Orange, NSW. Rob Homer


A Regis spokesman says the company regularly evaluates capital allocation and has no plans to raise capital and buy out its hedge book. “We already take advantage of the current spot prices as [around] 75 per cent (in FY23) of our gold production remains unhedged and exposed to the spot gold price,” the spokesman said.

Russo says Regis’ historical mistake is not representative of the mining sector’s broader hedging strategy, as the majority of miners in the senior ranks of the ASX were juniors before the 2012-13 crisis. They all hedge to varying degrees.

Perseus has locked in 24 per cent of its forecast production over the next three years at $US1968 per ounce, in line with its policy to hedge up to 30 per cent of total production over a rolling three-year period.

“The very disciplined application of the policy has served us very well to transform the company into a very profitable mid-tier gold producer and we cannot contemplate the circumstances under which we would consider amending this policy,” says chief executive Jeff Quartermaine.

“Some may say, ‘Well what happens if the gold price goes to $US2500 an ounce?’ Well, what I would say to that is 76 per cent of our production will be sold at that high spot price and the balance will be sold at $US1968 so it’ll average itself down slightly from the spot price.

“In a situation where the gold price falls, and let’s be honest, that’s quite possible as I’m old enough to have seen it happen a few times over my career, we will be able to sell at least 24 per cent of our production at darn near $US2000 an ounce.”

Very few stocks are unhedged, such as Western African Resources and Gold Road. Evolution Mining will soon become the only top-three miner – among Newcrest and Northern Star – not to be hedged from June 2023.

Evolution’s managing director, Phil Hoskins, said on the miner’s March-quarter earnings call this week the company will be fully exposed to the spot price from the second half of this year.

Northern Star, which is releasing its quarterly results on Thursday, is an outlier with the most locked-in hedging at $2673 an ounce. The miner locked in hedging for the acquisition of the super pit with Saracen, but it also has an “atypical policy to hedge out up to four years”, says Morgan. “In the next 12 months they’ve got about 400,000 ounces hedged, that’s about a quarter of their production.” The miner was unavailable for comment.
Margin squeeze

Although Franklyn and Baker agree hedging should be used to secure debt funding for projects, they argue it should be applied in a discreet and limited way. The best hedge against lower gold prices is lower costs, says Baker.

“If gold prices fall, input prices generally fall. If gold prices rise, input prices are generally rising, which squeeze margins if you are hedged – and the margin is what we are buying,” the fund manager says.

But Russo hit back, saying gold prices may be high, but so is production.

“With a couple of rare exceptions what you’re seeing is businesses making decisions to bulletproof their bottom line from whatever might come. It’s not a view on today’s price it is an acknowledgement they are required to commit capital in a highly volatile and uncertain environment,” Russo says.

Despite hedging squeezing returns for investors, Franklyn is optimistic. In the upcoming March-quarter results he will zero in on whether miners are generating free cash flow because last year the lower gold price and increasing cost pressures crushed margins.

Australian-domiciled miners are not as exposed to a stronger US dollar, which means they should remain profitable during periods when the greenback is weighing on gold, but the Australian currency is holding up.