21 August 2008

Producer (de)Hedging

Every quarter www.gfms.co.uk release their Global Hedge Book Analysis. I've been tracking it for a while now as it makes for a very interesting chart (see below). Quarter 2008 report was released last week.
Seems to be a very strong correlation between the decline in the hedge book (producer de-hedging creates demand for gold) and the rise in the gold price. "What," you say, "the increase in the gold price is not entirely due to the fall in the US dollar and the massive huge demand for US Eagle coins?" Yes, that is correct apprentice goldbug, things are not a simple as some ranters, sorry commentators, would have you believe.

Interesting to note that the de-hedging for the first six months of this year has been 8,000,000 ounces. Sales of US Eagle for the 7 months of this year have been 311,000 ounces. Now don't get offended American coin buyers (and I think it is good you are buying physical) but YOU DON'T MATTER when it comes to making an impact on the gold price.

This chart raises two questions:

1. De-hedging cannot continue forever, it is the lowest it has been since 1987, as it runs down to zero it will remove a source of demand that has been there since 2001.
2. When sentiment changes and producers decide to hedge again, watch out.

Maybe this recent fall has been exacerbated by a miner deciding it is time to lock in these historically high prices? Maybe not. Either way they aint gonna tells anyone beforehand and once the announcement is out, it isn't going to be pretty. About time market commentators started to analyse the statements of the CEOs of producers for hints of their intentions and provide their subscribers with forwarning.


  1. Thank you, Bron. I found you on Seeking Alpha and am delighted to read your blog. I visit the gift shop and the second floor from time to time.

  2. Interesting, but doesn't make sense. If producers were hedging, again, the physical supply would be up. But, it is very clear that, except for the paper contracts flying around on the COMEX, real supply of physical metal, both of gold and silver, is sharply DOWN this year. So, it cannot be a return to hedging that is causing the fall in gold prices. Remember, India sucks up 750 tons of gold every year, and China another 400 tons (this year). The increase in China, alone, will suck up all possible hedges. But, there can't be any, because gold and silver, especially silver, are in exceptionally short supply now, at these prices. If can only be explained by market manipulation as suggested at Seeking Alpha.

  3. Nice blog, Bron, found you at Seeking Alpha as well. Most gold hedging (actually forward selling which isn't really a hedge) was a condition of mine finance. Voluntarily hedging as you describe is typically via put or participatory options (leaving upside exposure) which in turn are hedged on COMEX by dealers in the commercial category. The commercial gross short position has been dropping fairly quickly in the last few weeks so it is very unlikely hedging is involved in this price decline.

  4. I do agree that miners have not been hedging, but it needs to be watched. Be careful focusing too much on COMEX - the over the counter market is much larger and miners can do forward selling and option and whatever other exotic financial BS instruments the wizz kids in a bullion bank can dream up in that market without it showing up on COMEX. Unfortunate fact is that gold is not a nice transparent market so makes it hard to work out what is going on.

  5. Bron,
    Certainly hedging and dehedging have an impact, but a study of the chart presented, and according to your logic, there should have been massive price declines in the early half of the chart. To be sure there was a price decline, but it seems pretty benign in comparison to your argument, and also in comparison to the huge stepwise manner in which the hedges were put on.
    The problem I have with the chart is that it represents the hedges as the quantity of gold involved. What is particularly important is the quantity and price at which the hedges were put on, not just the amount of gold overall. I'm not sure that sort of data is available, but I think it is necessary in order to arrive at any firm conclusion.
    As Silveraxis pointed out a lot of hedging was involved in miners seeking and obtaining bank finance. Again, the price of the hedge is important here, because the cost of production is providing an ever higher hard floor under the market. Ironically the hedges that bankers insisted on to provide security on their loans may achieve the opposite effect, when the remaining hedged miners fail and production is consequently negatively impacted. I wonder what bankers will do with a defunct gold mine and defaults on delivery of the hedged bullion ?

  6. What you say is correct Keith, there are many factors impacting on the price, I was just trying to highlight one because no one seems to mention it. Also, I should have noted that the step-like nature pre 2000 is because i only started recording gfms monthly data from then, prior to that i found another source with annual/year-end volumes so can only show stable balance for the whole year, I suppose I should have smoothed it out over the years 88-99.

    What is actually more relevant is month-on-month changes, not so much the total outstanding, and also price. If you have the time, it is worth checking our gfms as the hedge book analysis is publically available and does analyse price and maturity in some fashion.

  7. Hi Bron,

    I have been checking out the hedge situation, but the GFMS source you referred to seemed very light on for data (I may be looking in the wrong place). I did however find a recent report from VM/Fortis. It provides quite a bit of detailed data, but will take a little while to digest.
    Unfortunately the data only goes back to 2006, but on the plus side includes an analysis of world ETF holdings, which is worth a look :
    Q2 2008 - Full Report

    Points of immediate interest :
    Two major hold outs in the hedges are Barrick and AngloAshanti. Together they represent 70% of the global committed ounces. Barrick has forward sales of 6.4 Mozs at $334 due this year. I suspect at this late date, they will simply deliver to market from their own production, rather than buy in the market to remove the hedge (unless they don't have enough production of course). I don't know their production costs per ounce, but I reckon its going to hurt Barrick quite a bit.

    In terms of your thesis, I will need to continue pondering.....

  8. Keith,

    Interesting note in the VM/Fortis report you provided link for: "The Australian ETF, the first to be launched, lost nearly half its holdings (10t) in one day during May" No explanation or comment. I know the story behind that, but that is for another blog.

    The GFMS hedge book reports are at http://www.gfms.co.uk/market_commentary.htm Latest one is http://www.gfms.co.uk/Market%20Commentary/Global%20Hedge%20Book%20Analysis%20Q208.pdf

    Very much similar in content to VM/Fortis one.

  9. Most forwards are offset in London via "leasing" physical metal or on one of the exchanges with COMEX being the largest. You can look at forward rates in both markets (LBMA and COMEX) over time and pretty much figure out if there is a lot of hedging or dehedging going on. Right now, I'd say no to both, but I suppose it is worth watching.

  10. Good point. In the end it all comes down to the lease rate (which is the interest rate of gold). In almost any "instrument" the key variables used to calculate the price of the instrument are the price of the two currencies and the interest rate of those two currencies.

    In my blog to-comment list is the lease rate, but that will have to wait until all this Hommel sutff has died down.