The recent slump in gold prices may have spurred some miners to consider hedging their gold sales, but the vast majority have so far resisted doing so because they expect gold prices will recover and they want full exposure to these gains.
Spot gold has fallen 21% since the year began, prompting gold miners such as Russia-focused Petropavlovsk PLC (POG.LN) and Tanzania gold explorer Shanta Gold Ltd. (SHG.LN) to hedge, locking in a portion of their future gold sales at a fixed price to manage their cashflows amid a weaker gold price environment.
For Petropavlovsk, which locked in prices for about half of its production until June 2014, the move is aimed at managing its debt burden. Shanta Gold has hedged gold sales equivalent to nearly half of this year’s forecast gold output until March 2014, to help cover its debt and capital expenditure requirements as it carries out a five-year plan for gold production growth.
Such moves may make sense for those companies, but investors generally prefer to hold shares in gold companies with full exposure to any potential rise in the price of gold.
“In principle, we’re anti-hedging,” said Catherine Raw, co-manager of BlackRock’s natural resources team, which has $5.9 billion invested primarily in gold-mining equity fund. “We own gold shares because we want exposure to the gold price.”
Gold miners risk losing money on hedges if they lock in their revenues for the long term at a fixed rate, but fail to control their costs in a similar fashion, Ms. Raw said.
The gold industry suffered heavily over the past decade when many large gold miners hedged their sales following a prolonged period of low gold prices only to see the prices take off and mining costs rise. Several large gold miners spent billions of dollars trying to unwind hedges that became a drag on profits over that period. Barrick Gold Corp. (ABX), the world’s largest gold producer, was the last large gold producer to unwind its hedges when it raised $5.1 billion in 2009 to buy them back.
Gold miners would have to be certain that the industry has entered a structural price decline before they broadly return to gold hedging, said Ms. Raw, but “that is not our view.” The downside risk to the current gold price is limited, as jewelry demand is robust and gold supplies are scarce, she added.
Gold producers are also reacting to the low gold price by shutting down unprofitable mines. Mark Bristow, chief executive of West African gold producer Randgold Resources Ltd. (GOLD), said last week he reckons that more than half of the industry’s gold output is unprofitable at the current gold price.
That said, Angelos Damaskos, CEO of Sector Investment Managers Ltd., which advises the Junior Gold Fund on $25 million worth of investment in 38 gold companies, said he believes the gold price has hit a floor and will rebound in the second half of this year. The gold price could even reach its previous record high of $1,920.94 a troy ounce, set in September 2011, by sometime next year, he said.
Although talk about hedging is creeping in among small to medium-size gold miners, investors and miners say it hasn’t yet become pervasive. On the contrary, a recent J.P. Morgan Chase survey found 61% of investors were still against miners hedging gold prices.
Gold producers continued to unwind their hedges in the second quarter following net dehedging in the first quarter, said precious metals consultant Thomson ReutersGFMS and Societe Generale bank in a jointly produced report.
GFMS and Societe Generale expect net de-hedging to prevail over the rest of the year, since gold producers may believe they have missed the opportunity to hedge at a lower price.
Gold sank to nearly a three-year low of $1,180.20 an ounce in June, but has since rebounded to $1,324.70/oz.
Current position of the market
SPX: Very Long-term trend – The very-long-term cycles are in their down phases, and if they make their lows when expected (after this bull market is over), there will be another steep decline into late 2014. However, the severe correction of 2007-2009 may have curtailed the full downward pressure potential of the 40-yr and 120-yr cycles.
Intermediate trend – SPX May be in the process of forming an important intermediate top. Confirmation is needed.
Analysis of the short-term trend is done on a daily basis with the help of hourly charts. It is an important adjunct to the analysis of daily and weekly charts which discusses the course of longer market trends.
The last newsletter was entitled “A TIME FOR CAUTION”. That warning has already been vindicated by the 25-point pull-back which took place last week. However, some follow-through will be needed to confirm that an intermediate top is in place. The Dow Industrials may already have done so, but the other indices are fighting going over the edge. NASDAQ has the strongest price pattern, but its breadth is just as bad as that of the NYSE. Since breadth tends to lead price and the DOW tends to lead other indices, it would not take much more to secure the needed confirmation.
Structure: If minor wave 5 is, in fact, complete, its pattern was unorthodox. Tony Caldaro points out that it is clearer in the DOW where it took the form of an ending diagonal triangle. If it is, it is only one of a whole string of completions: minute v, minor 4, intermediate V and major 3, and this should be followed by a very decent correction.
Breadth: As we will see later on, in turning down from a much lower level than its previous top, the NYSI has created a very strong negative divergence pattern which should give even the most ardent bulls a cause for concern.
P&F and Fibonacci projections: Should we start down from the current level, the standard EW projection after any wave 5 completion is the level of the 4th wave of lesser degree. That would mean a retracement perhaps as low as 1560. Of course, I will provide my subscribers with a much more specific – and accurate – projection once we have a confirmed reversal.
Support/resistance zones: SPX has broke minor support when it traded below 1701. The more important level of 1585 has already been tested twice with the second bounce weaker than the first. If that level is broken, only one remains at 1676. The DOW has already broken all three comparable levels.
Sentiment: the SentimenTrader long term indicator has ticked down from slightly elevated to a neutral 50. We’ll examine the VIX chart a little later on.
A friend posed that question to me a few weeks ago, after watching gold’s wild ride over the last few years. The price of gold was less than $500 an ounce in 2005, but soared to more than $1,800 in 2011, before falling back to about $1,300 recently. He wasn’t sure what to make of it all.
My instinct was to say no. Like most economists I know, I am a pretty boring investor. I hold 60 percent stocks, 40 percent bonds, mostly in low-cost index funds. Whenever I see those TV commercials with some actor hawking gold coins, I roll my eyes. Hoarding gold seems akin to stocking up on canned beans and ammo as you wait for the apocalypse in your fallout shelter.
But I was also wary of imposing my gut instinct on my friend, who was looking for a more reasoned judgment. I knew that some investors saw gold as a key part of a portfolio. The author Harry Browne, the onetime Libertarian presidential candidate, recommended a permanent 25 percent allocation to gold. In 2012, the Federal Reserve reported that Richard Fisher, president of the Federal Reserve Bank of Dallas, had more than $1 millionof gold in his personal portfolio.
So, before answering my friend’s question, I dived into the small academic literature on gold as a portfolio investment. Here is what I learned:
THERE ISN’T A LOT OF IT The World Gold Council estimates that all the gold ever mined amounts to 174,100 metric tons. If this supply were divided equally among the world’s population, it would work out to less than one ounce a person.
Warren E. Buffett has a good way to illustrate how little gold there is. He has calculated that if all the gold in the world were made into a cube, its edge would be only 69 feet long. So the cube would fit comfortably within a baseball infield.
Despite its small size, that cube would have substantial value. In a recent paper released by the National Bureau of Economic Research, Claude B. Erb and Campbell R. Harvey estimated that the value of gold makes up about 9 percent of the world’s market capitalization of stocks, bonds and gold. Much of the world’s gold, however, is out of the hands of private investors. About half of it is in the form of jewelry, and an additional 20 percent is held by central banks. This means that if you were to hold the available market portfolio, your asset allocation to gold would be about 2 percent.
ITS REAL RETURN IS SMALL Over the long run, gold’s price has outpaced overall prices as measured by the Consumer Price Index — but not by much. In another recentN.B.E.R. paper, the economists Robert J. Barro and Sanjay P. Misra reported that from 1836 to 2011, gold earned an average annual inflation-adjusted return of 1.1 percent. By contrast, they estimated long-term returns to be 1.0 percent for Treasury bills, 2.9 percent for long-term bonds and 7.4 percent for stocks.
Mr. Erb and Mr. Harvey presented a novel way of gauging gold’s return in the very long run: they compared what the Roman emperor Augustus paid his soldiers, measured in units of gold, to what we pay the military today.
They report remarkably little change over 2,000 years. The annual cost of one Roman legionary plus one Roman centurion was 40.9 ounces of gold. The annual cost of one United States Army private plus one Army captain has recently been 38.9 ounces of gold.
To be sure, military pay is a narrow measure, but this comparison offers some support for the view that, on average, gold should keep pace with wage inflation, which, thanks to productivity growth, runs slightly ahead of price inflation.
ITS PRICE IS HIGHLY VOLATILE Gold may offer an average return near that of Treasury bills, but its volatility is closer to that of the stock market.
That has been especially true since President Richard M. Nixon removed the last vestiges of the gold standard. Mr. Barro and Mr. Misra report that since 1975, the volatility of gold’s return, as measured by standard deviation, has been about 50 percent greater than the volatility of stocks.
Because gold is a small asset class with meager returns and high volatility, an investor may be tempted to avoid it altogether. But not so fast. One last fact may turn the tables.
IT MARCHES TO A DIFFERENT BEAT An important element of an investment portfolio is diversification, and here is where gold really shines — pun intended — because its price is largely uncorrelated with stocks and bonds. Despite gold’s volatility, adding a little to a standard portfolio can reduce its overall risk.
How far should an investor go? It’s hard to say, because optimal portfolios are so sensitive to expected returns on alternative assets, and expected returns are hard to measure precisely, even with a century or two of data. It is therefore not surprising that financial analysts reach widely varying conclusions. •
In the end, I abandoned my initial aversion to holding gold. A small sliver, such as the 2 percent weight in the world market portfolio, now makes sense to me as part of a long-term investment strategy. And with several gold bullion exchange-traded funds now available, investing in gold is easy and can be done at low cost.
I will continue, however, to pass on the canned beans and ammo.
N. Gregory Mankiw is a professor of economics at Harvard.