“I can’t see that gold prices will go up if the lease rates are kept down, because it is just too much of an incentive to short sell,” Macdonald said. “So the only environment where the gold price is going to go up is if the lease rates are up at the same time and the central banks hold true to their promise by holding back on their lending.”
If lease rates were to increase and then hold at these levels for an extended period amid a rising gold market, Macdonald expects some Australian producers will be forced to deliver gold at prices below the spot price.
“That is not a major disaster. But in terms of relations with shareholders, it is not a good thing to be doing. It is untested waters as to the reaction of the shareholders to a company that delivers gold at a price below spot,” he said.
If there is an investor backlash, Macdonald predicts the major winners will be “unhedged smaller producers and the explorers”
Australian gold miners have long enjoyed hedging profits generated by the discount of gold lease rates to bank bills. But the complex derivative strategies used in the process are way beyond the understanding of most investors.
“We’ve evolved into an industry that is not easily comprehendible by shareholders, which is a shame,” Macdonald said. “One way to simplify the debate is to recognise that all gold companies lie on a continuum. At one end is the unhedged mining company, characterised by full exposure to the gold price. At the other end is a ‘contango capture’ company, one that relies on a contango for income. Mining companies come under threat when the gold price falls; contango capture companies only come under threat when the contango falls.”
According to Macdonald, most investors are still under the impression they are buying gold companies rather than “contango capture” companies, and buy shares for exposure to a rising gold price. “Disillusionment will inevitably follow any significant rise in the gold price.”
Even worse, he points out there are no disclosure or accounting standards in place for hedging activities. “The complexity of the field and the absence of independent audit requirements opens hedging activities to abuse and misuse by companies. Shareholders are condemned to finding out about hedging problems after the fact,” Macdonald said.
The recent debacles involving African gold miner Ashanti Goldfields and Canadian group Cambior shook up some gold bugs. Those two companies teetered on the edge after gold’s sudden surge left them with hefty margin calls from their hedging counter-parties — bullion banks. Basically Ashanti and Cambior were caught short, highlighting the often forgotten fact that hedging is a two-way street not devoid of risk.
The threat of uncovering skeletons in hedge books dominated discussion at the recent Denver Gold Forum in the US. However, major Australian producers shrugged off the US concerns.
“A lot of people who hadn’t been keen on hedging took the opportunity to throw a bit of rubbish around (at the forum),” said Peter Lalor, chairman of Sons of Gwalia. “So what you’ve got to a degree is a resurfacing of North American views on hedging, which is that they don’t favour it.”
So are there any time bombs hidden in Australian hedge books? Lalor said SOG, Normandy Mining, Delta Gold, Acacia Resources and Newcrest Mining were united in their firm stance at Denver.
“None of the Australian producers have got margin calls,” he said. “Most of the Australian books are quite mature. One of the reasons these problems occurred in America is that a lot of hedging was put in place in the first half of calendar 1999 at $US250-260/oz. So when the price ran up to $US330/oz, a lot of those companies weren’t in a good position, because they were way out of the money and some of them had granted call options to buy puts. And there were margin calls in some cases.”
SOG hasn’t done any hedging since early 1997. “All of our books are quite mature and in Australian dollars. So none of us (Australian gold producers) were in a position where the gold price running up caused us a lot of difficulty,” Lalor said.
And lease rates? He said SOG had locked in lease rates “in different forms over the next few years”
“So we would not be exposed if lease rates went to 6-7% and stayed there. It would have an impact on our business longer term, but in the next few years it would hardly impact at all.
“I’d be of the view that in the next year or two, there is no reason to believe that there won’t be sufficient liquidity in the gold market to keep lease rates at a reasonable figure. Somewhere between 1.5-2.5%.”
