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Posts Tagged ‘hedging’

Bulk offers miners some relief

September 23, 2011 Comments off

“The London Metal Exchange, where copper, aluminium, zinc, nickel, lead and tin change hands, is providing minute-by-minute insight to the subsequent share price moves of large mining companies. With LME metals in free fall, the shares of companies such as BHP Billiton, the world’s largest miner by market capitalisation, have followed.

With copper down 8.6 per cent and nickel a hefty 17.5 per cent on Thursday, extending big losses earlier on the week, it is understandable why miners’ shares are tumbling. More could come if LME prices continue to drop, as they are in early Friday trading. But that exclusive focus on LME metals ignores the real cash-cows of the mining sector: iron ore, thermal coal and coking coal. Prices are holding rather well this week.”

Source: Financial Times, September 23 2011

Observations:

  • For London-listed miners the LME-metals account for 33% of earnings, with 53% from iron ore and coal (thermal and metallurgical).
  • Nearly all commodities lost 5% or more of their value in the spot market on Thursday and Friday.

Implications:

  • Falling commodity prices signal doubt about continued economic growth is starting to affect traders, despite miner’s comments that demand is staying strong. The falling premium of lump ore over fines confirms the view that we might be past the peak of prices.
  • Miners will need to decide again about hedging (part of) their production to benefit longer from high prices. Long term supply contracts for bulk materials do serve as a sort of hedge, but metals-prices could also be hedged using derivatives.

©2011 | Wilfred Visser | thebusinessofmining.com

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The Economist: the wacky world of gold

June 2, 2011 Comments off

“Gold is not like other commodities. … Yet gold miners’ shares have failed to keep pace. This is new. Gold and gold-mining shares used to rise and fall in lockstep. Over the past five years, however, the price of gold has trebled while the value of gold miners has merely doubled. Investors in firms that shift, crush and process rocks are more grounded, it seems, than those who invest in bullion.

As mines age, extracting gold gets harder and costlier. Ores give up less of the metal—average grades have fallen by 30% since 1999 according to GFMS, a consultancy. And ore must be hauled up from ever greater depths. Fuel is pricier. So, too, are labour and equipment, since the global minerals boom has driven up demand for miners and drills.

Finding new seams to replace depleted ones is becoming harder. Metals Economics Group, a mining consultancy, estimates that in 2002 gold miners spent $500m on exploration. By 2008 they were spending $3 billion but finding much less. All the easy gold has been mined already.”

Source: The Economist, June 2 2011

Observations:

  • The Economist identifies several reasons for the share price of gold mining companies to stay behind compared to the gold price: hedging limiting many miners benefits; increasing geopolitical risks; commodity diversification of gold miners; and the emergence of other methods to invest in gold.
  • The article mentions investment demand as the most important source of demand for gold. However, although this demand class is increasing in importance, demand for jewelry (mainly in India and China) still is the most important source of demand (see UBS-graphs below).

Implications:

  • The Economist fails to realize the importance of the supply side impact on the gold price. Miners are not the only source of gold in the market. Over 25% of supply is ‘scrap gold’, recycled from either jewelry or devices. Furthermore, historically the sales of gold reserves by central banks has strongly impacted the gold price.
  • Another important aspect of the gold supply dynamics not mentioned in the article is the development time lag: from investing in the search for gold to producing the first gold will easily take 5-10 years. The boom in gold exploration triggered by the high gold prices is now starting to result in supply increases, with production exceeding the previous 2001 peak. If gold prices stay high, the world will certainly see a slow further capacity increase.

©2011 | Wilfred Visser | thebusinessofmining.com

Gold and copper prices push Barrick to record

February 18, 2011 1 comment

“Surging gold and copper prices propelled Barrick Gold to record earnings of almost $900m in the fourth quarter, but the world’s biggest gold producer warned of escalating cost pressures. The Toronto-based company reported lower operating costs last year but Aaron Regent, chief executive, said that inflationary pressures “have become more pronounced” across a broad front, including raw materials, freight and labour. Mr Regent added that demand for these inputs is accelerating as mining projects around the world are brought forward to take advantage of buoyant commodity markets.

In a partial reversal of its aversion to hedging, Barrick said that it had taken advantage of high spot silver prices and attractive option terms to guarantee prices on 15m ounces of silver, which is equal to 10 per cent of Pascua Lama’s output in the five years from 2013 and 2017. The strategy will ensure prices of $20-$55 an ounce.”

Source: Financial Times, February 17 2011

Observations:

  • Barrick took a $4.2bln hit in 2009 to eliminate the hedge book. Net cash inflow in 2010 was $4.8bln, leaving the company with $4bln in cash, of which just over half is planned to be spent on capital expenditure this year.
  • Total cash cost for the production of last year was $457/oz., with Q4 almost $30/oz. higher. Costs are down compared to last year (with low production), but up 32% from 2007 levels.

Implications:

  • The return to hedging gives a signal that Barrick expects the silver price not to rise further. In the ’80s and ’90s Barrick used an extensive gold price hedging strategy, in which the full production of the next 3 years was continuously hedged. With the falling gold prices in this period this was a profitable strategy. In 2003 the company decided to stop hedging to gain exposure to increasing gold prices. However, the open hedges for many years were very costly as gold price never returned to 2003 levels.
  • The cost increase experience by Barrick is in line with increasing cost figures diversified miners announced this week. Controlling operational costs will return to the priority lists in order to protect margins when commodity prices decrease.

©2011 | Wilfred Visser | thebusinessofmining.com

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