Company Forward Selling

The second form in which mining companies contribute to the supply is through hedging or forward sales. Although it is very complicated, the nuances of forward selling are very important for investors to understand. The two main players in forward selling are the central banks and the mines. Forward selling is an inexpensive and convenient form of mine financing for the mines. For the central banks, it is a way to make interest on an otherwise dormant balance sheet item. Through the bullion bank intermediary, the mines borrow gold from a central bank and swear to pay back the loan from production in the near future.

Some mine company forward sales contracts extend over the years, sometimes up to ten years. The loaned money is sold by the mining company on the open market and uses the proceeds to finance the mining operations or to buy higher-yielding instruments in financial operation which is called a carry-trade. The main purpose of the gold market is that, for either purpose, forward selling gets gold to the market that couldn’t have been available in any other way, this way they are creating fantastic downward pressure on the price.

Once the production is sold forward, it can never be sold again. If the price of gold were to start going up, like it did in two thousand-two and two thousand-three, the company will not only lose its money on its hedge site, the value of its stock will be hurt too.

During the most recent bull market in gold stocks, non-hedged or marginally hedged miners outperformed the strongly hedged companies by an embarrassingly wide range. In two thousand-four with gold trading in the four hundred dollar range, one of the most important gold mining companies informed that it suffered an almost one point seventy-five billion dollar loss because of its massive hedge site. It followingly promised to reduce the firm’s vulnerability to gold’s upside through a process known as dehedging. Dehedging, which is buying gold on the open market and using it to repay gold loans early, which is the exact opposite of hedging.

Forward selling in these years has come under intense attack from sophisticated gold stock investors, who look upon it as contrary in the purpose of a mining company. These shareholders ask themselves why they are involved in financing operations that essentially act to hold down the price of the same commodity that they are in the business of producing. This complaint has had a management impact in principal gold mining companies and their answer has been to reverse their hedge sites. The same gold mining companies that added an average of two hundred tones a year to give over the past ten years instead have added five hundred tones to demand over the past couple of years.

Take that supply away from the tables and you get a run-away gold cost. As a matter of fact, the majority of the gold market experts credit the reversal in mine company hedging practices as the key to gold’s increment from two hundred-fifty dollars to four hundred-thirty dollars since late nineteen ninety-nine. Due to the hefty hedge sites accrued by mining businesses during the nineteen nineties the possibility of even more dehedging in the future still remains strong. The tonnage that is to come from this new demand category could very possibly take the market by surprise and contribute to the bullish argument for gold for many years to come.