New Gold Inc. was braced for any vicious backlash in the investment community if this decided to hedge some gold production earlier this month.
After all, hedging is the gold industry’s ultimate dirty word. It became such a toxic subject during the last decade that many chief executives decided that even talking about it was off limits. And New Gold is led by Randall Oliphant, who headed up Barrick Gold Corp. when it had the largest – and most reviled – hedge book in the industry.
But the reaction to New Gold’s move wasn’t negative. Instead, just about everyone cheered.
“We’ve heard nothing but positive reactions from shareholders, analysts and media individuals to what we should did,” said Oliphant, New Gold’s executive chairman. “So which will give individuals that do sort of stuff some ammunition.”
New Gold’s hedge position is fairly minor in the grand scheme of things. The Toronto-based miner entered option agreements to sell 270,000 ounces of gold at prices no lower than US$1,200 an oz. New Gold is spending a hefty US$500 million with an Ontario gold project in 2016, which small hedge position simply ensures that it can build the mine and keep a healthy balance sheet even when gold prices use the tank.
Still, this deal violated one of the industry’s biggest taboos and it took some nerve for brand new Gold to get it done. However the warm reception it received, combined with the recent rally in gold prices, suggest there might be much more hedging in the future.
The heyday of hedging came in the 1990s and early 2000s, when gold was mired inside a prolonged bear market. Companies for example Barrick, Newmont Mining Corp. and AngloGold Ashanti Ltd. hedged millions of ounces of future production to secure profitability in their operations. The practice peaked in 1999, when a lot more than 3,000 tonnes (or higher 100 million ounces) of gold was hedged.
Anti-hedgers ignore an obvious truth: during the bear market, hedging often paid off
The gold bugs despised this financial engineering, because miners were giving away much of the upside to rising gold prices. Of course, one reason for the hedging was that the mining companies simply didn’t believe gold would go up around it did.
But the anti-hedgers ignore an obvious truth: throughout the bear market, hedging often repaid.
Barrick, for one, grew into the world’s biggest gold miner largely because of its hedge book, which allowed it to make more profit per ounce than many of its rivals. As a result, its stock traded at a premium to many from the sector, and it could then use that stock as currency for acquisitions.
But the downside of hedging became obvious when gold began its long upward climb in 2001. As prices rose far above the levels where companies hedged, the industry’s hedging liability became larger and larger.
The smarter companies, for example Newmont, eliminated their hedges relatively early in the bull market. Barrick, however, waited until 2009, at which point gold had quadrupled from the lows and was worth roughly US$1,000 an ounce. The company ended up issuing US$4 billion price of stock – still the largest equity offering in Canadian history – simply to unwind its 9.5-million-ounce hedge book.
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No one desired to replicate that nightmare, and hedging was pretty much dead by the dawn of this decade. Just 152 tonnes of gold remained hedged at the end 2010, based on GFMS analysts at Thomson Reuters, which is under five per cent from the 1999 peak. By 2012, that figure was right down to 130 tonnes.
Gold prices rose every year between 2001 and 2012, there wasn’t any shareholder support for hedging. Hedge funds along with other institutional investors were piling into the sector to get contact with gold’s rising fortunes, and they wouldn’t touch a company having a significant hedge book.
But the gold bull market ended abruptly early in the year of 2013, when prices plunged 25 per cent in a matter of weeks. Gold miners suddenly realized an unfortunate truth: most of them weren’t coming to a money.
Had they hedged some production at any time previously two years, they would have created a great buffer against falling prices. Instead, some of them struggled just to stay afloat and manage their large debt loads.
The gold market has turned positive again in 2016. Prices have jumped as much as 20 per cent because the start of the year (they remain above US$1,200 an ounce despite slipping last week) so it is sensible for businesses to consider seriously about hedging again.
New Gold announced its hedge on March 8. Just 7 days later, Canadian miner B2Gold Corp. announced it is raising up to US$120 million from prepaid gold sales, which comes down to a kind of hedging. That capital is going to be used to build B2’s Fekola mine in Mali.
Hedging is gaining popularity outside Canada as well. Several Australian and Africans firms, including Evolution Mining Ltd. and Acacia Mining PLC, have announced new hedge positions in recent months, as has Polyus Gold, Russia’s leading producer.
These transactions, all of which are relatively modest in dimensions, point to exactly what a new era of hedging could look like. It will not be the massive financial engineering schemes of days gone by which were orchestrated by corporate finance whizzes trying to outsmart the gold market.
Instead, it will likely be utilized in small, targeted doses by companies seeking to protect their balance sheets or reach a particular goal, for example funding a new mine.
“Hedging for a specific reason or a specific project has always designed a lot of sense within the mining industry,” said Clive Johnson, B2Gold’s CEO. “The fact of the matter is the fact that (Barrick and others) gave it a bad name. However i never visited.”
Despite the small revival this season, it remains seen if hedging can totally shed its negative stigma and gain wide acceptance again. It still is not a word many executives will say out loud.
But as hedging went out of favour over the past decade, the industry embraced another financing scheme that has some similarities: metal “streaming,” where a mining company receives upfront cash from a streaming firm (for example Silver Wheaton Corp.) in exchange for future sales of physical gold and silver at below-market prices.
Mining companies raised US$4.2 billion from stream sales in 2015 alone, according to Financial Post data. Barrick, Teck Resources Ltd. and Glencore PLC are among the companies that eagerly sold streams this past year.
Some experts are surprised that streaming is becoming very popular while hedging remains beyond the pale. In certain circumstances, streaming can be very expensive. If metal prices increase after a stream sale, the miner winds up giving away a lot of profit.
Streams also usually continue for the whole life of a mine, and include the exploration upside. Therefore if a company finds more silver or gold on its property after signing such a deal, it must sell a portion of this new discovery within the stream as well.
Johnson said the streaming model doesn’t make sense for an organization such as B2Gold, which has a well-regarded exploration team and is noted for buying projects and then finding more gold in it.
“The streamers want a bit of the upside forever,” Johnson said. “With our capability to find more ounces, there’s no way I’m going to give those up.”
There continues to be some backlash against streaming deals recently, as commentators have expressed concern that miners are quitting an excessive amount of upside in order to get immediate influxes of cash.
Ironically, those concerns could create more hedging, which faced similar criticisms two decades ago.
Ron Stewart, an analyst at Dundee Capital Markets, said there are still lots of investors that see hedging being an “evil financing tool.” But those same people probably think streaming deals are extremely expensive and may discover their whereabouts as an even worse alternative.
“It might actually be that streaming and royalty deals have turned hedging back into something which is a touch little more palatable,” he said.
For New Gold’s Oliphant, the argument towards hedging is a lot simpler. He pointed out that gold was US$1,050 an ounce just 3 months ago, when compared with Thursday’s closing price of US$1,223 along with a peak of US$1,277 earlier this month.
Miners generally have short memories, however, you don’t need an extended one to recall how much the was suffering at US$1,050 an ounce just 3 months ago. In those days, locking inside a floor price almost 15-per-cent higher, as New Gold just did, would have felt wonderful become a reality for many executives.
“People know exactly the way they felt whenever we were at those affordable prices,” Oliphant said.
pkoven@nationalpost.com
Twitter.com/peterkoven
