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| From: | "malcolm coleman" <malcolmcoleman@hotmail.com> |
| Date: | Sun, 16 Jun 2002 12:09:38 +0000 |
HEDGE EDGE MAY SPARK MAD SCRAMBLE
SAN FRANCISCO (CBS.MW) - As gold's polar opposite, Nasdaq, gets
blasted, bullion investors expect miners' risky hedge books to further
boost the metal.
By some estimates, gold mining companies are hedging, or selling
forward, about 4,000 tons of gold. Some analysts say it's far more. As
gold prices continue to rise in the face of a weak stock market and a
declining dollar, most of the world's largest hedgers are looking for
ways to reduce the hedge risk from their books.
Earlier this week, South Africa's AngloGold Ltd., the second largest
gold miner as measured by production, indicated it would continue to
slim its hedge book. The company took 105 tons of gold off its
forward-sale program in the six months ended March 31.
Other highly hedged companies, including Canada's Barrick Gold (ABX),
say they will keep slimming their use of derivatives and the bullion
leasing market to hedge gold production. In bad times, when gold prices
were below $300, such practices created extra revenue for gold
companies. Hedged instruments harvested a higher gold price than was
available in the spot market for bullion.
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Yet critics of the practice long have pointed out how hedging by gold
miners battered the gold price, mostly by encouraging the lending of
central banks' gold reserves to investment banks, which then design
hedge programs. Essentially, hedging of any type is a short-sale against
the price of gold. Now that gold is flirting with $330 an ounce in the
spot market, gold's most outspoken investors see the hedge-rush adding
speed to the gold rush.
"I see $340 and $360 an ounce as the danger zone for banks, that is
where hedging and the hedge book problems start to have an impact," said
Ian McAvity, editor of Toronto newsletter Deliberations on World Markets
and a director of gold and silver closed-end fund Central Fund of Canada
(CEF). "I expect to see a $25 up day for gold one day, largely due to
someone getting skewered by their hedge book, either the bank that
extended it or the mining company."
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A rapidly rising gold price is the worst enemy of hedged miners and the
banks that designed their derivative strategies. A powerful gold rally
could force some miners, or the banks behind the hedge books, to engage
in a mad scramble to locate gold and deliver it to the original lenders.
McAvity points to the largest investment banks, among them JP Morgan
Chase (JPM), as facing the most risk from the continuing gold rally.
Gold's spot price is up about 20 percent since Jan. 2. Figures from the
Office of the Comptroller of the Currency show JP Morgan Chase having
the largest exposure to gold derivatives among U.S. banks and trusts, as
of Dec. 31.
JP Morgan Chase held $41.04 billion of gold derivatives of all
maturities as of Dec. 31, according to the Comptroller of the Currency.
The total amount of gold derivatives for U.S. commercial banks and
trusts last year was $63.3 billion.
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McAvity sees the declining dollar and the move away from Nasdaq and
other expensive company shares as positives for the gold price. The euro
is zeroing in on 95 cents vs. the dollar for the first time since
January 2001. The dollar has lost about 7 percent against the currencies
of its major trading partners thus far this year.
"The financial asset mania of 1982 to 2000 is now giving way to a
return to tangibles, and a precious metals trend that should run for
many years," McAvity says.
The gold fund manager most outspoken about the evils of hedging, John
Hathaway, sees fiscal distress for many parties as gold prices rally.
Hathaway's Tocqueville Gold Fund has gained 81 percent since Jan. 2,
holding largely unhedged mining companies such as Gold Fields Ltd. (GFI)
and Harmony Mining (HGMCY), both from South Africa.
"There is a huge outcry against hedging among investors," says
Hathaway. "Mine company managements have received a loud message from
the investment world to cover their hedge books, and all but the most
obtuse will be doing so."
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Hathaway sees gold mining companies issuing new shares to buy physical
gold that they use to ameliorate, or cover their forward sales of
bullion. "Durban Deep (DROOY) was the first to do it, and I believe
there will be other, bigger players," he said. Durban is a South African
company whose shares have gained 290 percent since Jan. 2.
Hathaway estimates each $10 rise in the gold price "means the
collective bullion dealers have extended another $1.4 billion to the
gold mining industry, based on a 4,000 tonne position."
Hathaway warns, "A $50 move, which is certainly in the cards, would be
$7 billion. What does this mean? It means a serious squeeze on the
bullion dealers, not the mining companies for the most part. Central
bankers who have lent the gold to JP Morgan, Morgan Stanley (MWD),
Goldman Sachs (GS) and others would not be happy with this situation."
What can the bullion dealers do about it? "Not a whole lot, other than
buying gold to cover their short, which is what they are starting to
do," says Hathaway from his Tocqueville (TGLDX) offices in New York
City. "Most mining companies, especially the big ones, have margin-free
trading agreements with their various dealers. This means they do not
have to advance cash when the gold price rises. It is too late for the
bullion dealers to go back to the mining companies to change the deal,
so they have no choice."
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Hathaway sees Wall Street clean-up crews at work, frantic in their
efforts to erase the gold derivatives. "There are all kinds of crazy,
exotic deals made in the past that will come to light -- exploding puts,
knock-in calls, etc., which had high fees originally but are now viewed
as toxic waste by the dealers who sold them."
The fund manager points out that actual gold supplies do not move
around as freely as those who need to cover their hedging strategies
would like. "Physical gold is illiquid relative to short covering
demand. This will take gold a lot higher, unless the central banks step
in, which I expect them to do when the gold market gets really
disorderly, like gapping $10-$20 a day or more."
See more on the hedge rush at CBS MarketWatch
http://cbs.marketwatch.com/news/story.asp?siteid=mktw&dist=nwtwatch&guid=%7BA43655AE%2D9EB9%2D4090%2DA939%2DC18F4BD66C8E%7D
.
Disclosure - Long on several ASX Gold stocks.
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