Posted On Friday, Sep 12, 2008
Gold Producers dig deep inside the earth’s crust to provide us with the golden glitter of the precious yellow metal. Gold is rare and it also retains value for a long period of time. Hence, it rightfully assumes the status of a noble metal.
Gold producers breathe gold day-in and day-out. No wonder, they are considered to be the “experts” in the international gold market. They have witnessed various economic cycles and have seen how gold demand, supply and prices have fared during these cycles. They have thereby gained a good understanding of the international gold markets and are in a great position to gauge where gold prices are headed. They have witnessed the huge gold price rise in 1980 which saw gold reaching new highs. They have also borne the impact of the precious yellow metal getting beaten down, on account of intervention by the central banks of various countries, towards the end of the last decade.
Let us try and analyse certain steps taken by gold producers in the recent past, and see if this can give us some indicators on the future trend of gold prices.
In the past, gold producers sold most of their future production in the forward markets to lock-in to the attractive prices prevailing at that point of time. This helped them to lock-in their profit margins and decide on the quantum of gold they would produce and release into the market in the future.
Gold producers now are reducing their future commitments significantly. By future commitments, we mean the quantity of gold that they sell in the forward / future markets at a fixed price. Gold producers are "de-hedging" . This in simple terms means that they are squaring off their outstanding forward sale positions. i.e. They are buying back gold , which they have sold earlier in the futures market.
There has been an increasing reduction in hedging by gold producers over the past few years. This decrease may imply that producers may be realising that they were hurting themselves by committing to deliver gold in the future at lower prices. In short, the producers are bullish, or at least, tired of lagging behind stockholders (ie. Those who buy from the producers). Over the past few years, the stockholders, at the expense of gold producers were benefiting due to the consistent increase in future gold prices.
According to metal experts, the de-hedging process is indicative of the gold producers’ expectation on the future trends in gold prices. If gold producers expected the price of gold to go down in the future, they would have tried to lock-in their future production at the prevailing higher rates. Obviously, by not doing so, since they expect gold prices to go up in the future!
We saw increased de-hedging activity during the first half of this year. We also saw record high prices during the same period. This implies that producers squared off their forward sale positions, and incurred losses even at higher price levels. This indicates that they expect gold prices to increase much beyond the record highs seen recently.
It is interesting to note that from 2005 to 2007, a majority of the de-hedging activity by gold producers was concentrated in the first half of the year. This could be because the second half of the year saw the maximum surge in prices during most of these years.
The producers are in the best position to understand future supply trends. They know that it is getting increasingly difficult to find new gold deposits. They also are aware that to extract good quality gold ore, they have to dig deeper in their existing mines. They are also faced with a hike in the cost of production of gold, due to increase in labour costs, exploration costs, power costs, mine rehabilitation costs, etc. In such a scenario, one can only expect gold prices to move upwards over the longer term.
Gold Producers seem to have chosen the right path by eliminating the forward sales which are fixed at a price which is way lower than the current price. The gold producers are de-hedging so that they can reduce the extent of their losses. Gold Producers are fully aware that there will be supply constraints in the future, while demand is only set to increase and therefore expect that future gold prices can only rise.
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