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.
See IRG research reports
