23 April 2009

Snarling the gold-leasing machinery

This article by Ambrose Evans-Pritchard in the London Telegraph has got a lot of runs in the past few days. This statement in it caught my eye

Low real interest rates have caused the process [mine hedging] to reverse, creating a shortfall of about 500 tonnes. The process accelerates as rates turn negative, leading to a scramble by market players to find physical gold.

My understanding of what drove mine dehedging was that investors were demanding no hedging so they could be fully exposed to the gold price. I didn't think real interest rates had anything to do with it. I was intrigued that maybe Charles Gibson of Edison Investment Research had found some correlation, so I dodged up the following chart, creating the real interest rate figure from the federal funds rate less CPI.

I can't see any correlation at all between the consistent miner dehedging and real interest rates. I think there must have been some misinterpretation by the journalist in trying to simplify the report into a brief news article.

The other statement that "this is what occurred in the late 1970s, driving gold prices to $850 and ounce" I would also disagree with. As you can see from the chart, mine hedging really only got going in the late 80s. I am speaking without direct experience but I don't think there was much, if any, lease market in the 70s/early 80s. Maybe it was meant that the forwards/futures machinery was upset in the late 1970s.


  1. This guy clearly does not understand the gold market and he is supposed to be an "expert"! Hedging and dehedging have nothing to do with interest rates, real or otherwise, but the incentive to hedge is certainly greater when the NOMINAL (NOT REAL) interest rate curve is steep because that would typically mean that the forward sale price of the hedged gold production is significantly higher than the spot price, and thus the miner does not stand to take a loss if the gold price rises by a moderate amount. At the same time, the large build of mine hedge positions during the 1990s was only possible due to the availability of central bank leased gold. Even if the miners wanted to hedge again today, the central banks are limited in new leasing under the CBGA. And without spot sales of leased gold, any new hedging would depress forward prices to the point where the hedged price would be significantly lower than the spot price, which is not something that gold miners would be happy about, shareholder approval or otherwise.

  2. I was trying to be nice. Looking at his profile on the company website, it just says he is a mining expert. I suspect he is spread across a lot of commodities.

    Right now it does not matter how attractive forward selling looks, shareholders don't want it.