An Articlefrom *Explainer: Howdoes gold hedging impact...

An Articlefrom *

Explainer: Howdoes gold hedging impact shareholder returns?

Angela East18/03/2020

With the recent run up in the gold price, which iscurrently trading at over $2,500 Aussie, now is probably a really good time forproducers not to be hedged.

Hedging involves a gold producer forward sellingfuture gold production at a fixed price to lock in guaranteed revenue, ratherthan taking its chances with the spot price if it falls.

It is a common practice by gold producers as a wayof protecting themselves against a slump in the price of the safe haven metal.But when there is a run in the gold price, like now, those that have hedgedcould miss out on significant additional cashflow.

According to a recent article by The Australian, if the gold price remains at record levels, several Aussie miners could sacrifice up to $2bn in extra cash because of ‘legacy’ hedges.

Roughly 3 million ounces of gold has been hedged atless than the current gold price by top miners including Newcrest Mining (ASX:NCM), Saracen Mineral Holdings (ASX:SAR), Regis Resources (ASX:RRL), Northern Star Resources (ASX:NST) and Evolution Mining (ASX:EVN).

But the level of hedging has dropped substantiallyover the years, according to data from Thomson Reuters and the World GoldCouncil.

© Provided by * hedging Source:GFMS, Thomson Reuters, World Gold Council

In conversations with various gold players,investment bank Goldman Sachs discovered the reasons behind the declineincluding — that hedging might imply a bearish company view on gold, it can betoo complicated to explain to investors, and it can be expensive.

These days hedging is more common when a new goldproducer has a large amount of debt it needs to guarantee it can pay back.

“Essentially, [hedging] was set up as a riskmanagement system to guarantee revenue for a company during tough times or whenthere’s a risk,” David McGowan, head of small cap gold producer Medusa Mining (ASX:MML), told *.

Medusa Mining, which has a sub-$100m market cap, isone of the few juniors that isn’t hedged.

“There’s a lot of things not going quite right orto plan at the moment in the world, so the gold price has gone upsignificantly,” McGowan said.

“It means our revenue goes up as well, essentially beingunhedged.

“Given that we produce at [costs of] somewherebetween $1025 and $1125, that’s a nice little margin on top that we didn’t planfor, but we’ll take.”

There are other unhedged juniors, but not many.

The +$250m market cap Tribune Resources (ASX:TBR) is not hedged, but it is currently embroiled in a legal dispute with JV partner Northern Star.

Alacer Gold (ASX:AQG), which has a market cap of around $335m, is also in the unhedged club, but it only has a secondary CDI (CHESS Depositary Interests) listing on the ASX. Its main listing is on the TSX. CDIs are a proxy for trading foreign shares on the ASX.

Tell us what you think

Do you think gold producers should hedge?

When is it a good time to hedge?

The problem gold producers face when decidingwhether to hedge or not is the potential impact it will have on shareholderreturns.

“That’s the trick; do I want to play roulette andgamble my shareholders’ money? If I go and hedge now and the gold price doesn’tgo up — therefore I’m making money when it goes down — in that case I’d bepatted on the back and told ‘you’ve done a great job’,” Medusa Mining’s DavidMcGowan explained.

“If I go out and hedge now and the gold price goesup to $US1800, I’d be looking down the barrel and trying to explain why Ishould keep my job.

“At the end of the day, it’s not to say that wewouldn’t consider hedging, but we see the potential for upside and with that weaccept the potential for downside.

“If [the price] goes down, as long as it’s abovewhat it costs us to produce, we’re going to make money.”

In simple terms, for every dollar that the goldprice goes up, a percentage of that covers royalties and income tax and therest goes straight into the bank.

“70c of [every] dollar goes into our bank,” hesaid. “That’s purely because we’re unhedged. So every time the gold price goesup, our bank balance should get healthier and healthier. That’s the upside.”

On the flipside, investors get nervous when thegold price goes for a run and fear all those gains will be quickly lost oncethe surge comes to an end.

“The difficulty is when the gold price goes for arun like it has now, we will have some investors telling us that we shouldhedge because it’s just going to fall,” McGowan said.

“There are a lot of gold producers that did thatsix months ago. There’s some Aussie gold producers that hedged 30 per cent oftheir production at $1800 Aussie dollars — they’re now missing out on $700 anounce that’s not going to their bank account, it’s going to whoever they hedgedwith.”

As mentioned earlier, hedging is an added cost.

“It is a cost to go and do, so you have to bereally confident that it’s the right step forward or you have to have a riskthat if your revenue drops by a certain point the company starts to drown andwe’re not in that position for a long way,” McGowan noted.

“Medusa has money in the bank, we have a goodhistory of consistent production now and we haven’t had anything at risk.

“So if the gold price didn’t go up, we would stillbe making money. At the end of the day if you’re a gold miner you have tobelieve in your product, you have to believe that the world wants it, you haveto believe that the world is going to pay a reasonable price for it.”