The difficulty in any decision with long-term consequences is that you simply don’t know what the future will be like it. You have to make an educated guess, based on inadequate experience and depleted brain cells. But basic logic can help.
Take Lihir Gold. The company announced yesterday that it would, “plow about $850 million into buying back its gold hedging to maxmise its exposure to gold prices, underscoring its faith in the gold market.” This is a good sign for gold, when gold producers finally begin to believe in the bull market of their own product. If you’re a really hard core contrarian, however, this might scare you.
But we assume it’s good, at least for Lihir shareholders, that the company is no longer selling today’s production at yesterday’s prices. Actually, if it were selling gold at yesterday’s prices, it wouldn’t be so bad. But when a gold producer hedges, it sells future production at a pre-set price in order to lock in the profits and cover the costs and ensure its operations continue.
It’s a risk. You could sell tomorrow’s gold at a hideous discount to what it might be worth. This, it turns out, is exactly what Lihir and other Aussie gold producers have done. Lihir sold current gold production for the bargain basement price of US$343 an ounce, compared to a gold price yesterday around of $690. That is what we in the industry call a bad bet.
Hindsight being what it is, is it fair to rap the company on the knuckles for not anticipating gold’s big bull move? Well, mostly yes and a little bit no. You can’t blame any man, woman, or gold miner for not knowing the future. The company gets a pass on that.
But as a going-concern with long-term obligations and assets (goldmines require capital investment that’s depreciated over decades, not years) surely the future direction of the gold price would enter into a company’s calculations. And surely when gold begun turning up in 2002, the gold producers might have realized that selling future gold production at locked- in prices would limit their exposure to any big moves up in gold.
That’s a lot of surelys. Too many, in fact. The gold producers did hedge, essentially betting against the bull market in the commodity they produced. And thus, their upside of selling current production at current prices (or higher) has been limited. This seems to have been a problem throughout the Aussie gold sector, and it’s only just now that companies are finding the cash to buy back their hedges and get, er, fully exposed to gold’s next big move, which, as gold bulls, we hope is up.
The Daily Reckoning Australia