- SAN FRANCISCO (CBS.MW) -
As gold's polar opposite, Nasdaq, gets blasted, bullion investors expect
miners' risky hedge books to further boost the metal.
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- By some estimates, gold mining companies are hedging,
or selling forward, about 4,000 tons of gold. Some analysts say it's far
more. As gold prices continue to rise in the face of a weak stock market
and a declining dollar, most of the world's largest hedgers are looking
for ways to reduce the hedge risk from their books.
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- Earlier this week, South Africa's AngloGold Ltd., the
second largest gold miner as measured by production, indicated it would
continue to slim its hedge book. The company took 105 tons of gold off
its forward-sale program in the six months ended March 31.
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- Other highly hedged companies, including Canada's Barrick
Gold news, say they will keep slimming their use of derivatives and the
bullion leasing market to hedge gold production. In bad times, when gold
prices were below $300, such practices created extra revenue for gold companies.
Hedged instruments harvested a higher gold price than was available in
the spot market for bullion.
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- Yet critics of the practice long have pointed out how
hedging by gold miners battered the gold price, mostly by encouraging the
lending of central banks' gold reserves to investment banks, which then
design hedge programs. Essentially, hedging of any type is a short-sale
against the price of gold. Now that gold is flirting with $330 an ounce
in the spot market, gold's most outspoken investors see the hedge-rush
adding speed to the gold rush.
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- "I see $340 and $360 an ounce as the danger zone
for banks, that is where hedging and the hedge book problems start to have
an impact," said Ian McAvity, editor of Toronto newsletter Deliberations
on World Markets and a director of gold and silver closed-end fund Central
Fund of Canada. "I expect to see a $25 up day for gold one day, largely
due to someone getting skewered by their hedge book, either the bank that
extended it or the mining company."
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- A rapidly rising gold price is the worst enemy of hedged
miners and the banks that designed their derivative strategies. A powerful
gold rally could force some miners, or the banks behind the hedge books,
to engage in a mad scramble to locate gold and deliver it to the original
lenders.
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- McAvity points to the largest investment banks, among
them JP Morgan Chase, as facing the most risk from the continuing gold
rally. Gold's spot price is up about 20 percent since Jan. 2. Figures from
the Office of the Comptroller of the Currency show JP Morgan Chase having
the largest exposure to gold derivatives among U.S. banks and trusts, as
of Dec. 31.
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- JP Morgan Chase held $41.04 billion of gold derivatives
of all maturities as of Dec. 31, according to the Comptroller of the Currency.
The total amount of gold derivatives for U.S. commercial banks and trusts
last year was $63.3 billion.
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- McAvity sees the declining dollar and the move away from
Nasdaq and other expensive company shares as positives for the gold price.
The euro is zeroing in on 95 cents vs. the dollar for the first time since
January 2001. The dollar has lost about 7 percent against the currencies
of its major trading partners thus far this year.
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- "The financial asset mania of 1982 to 2000 is now
giving way to a return to tangibles, and a precious metals trend that should
run for many years," McAvity says.
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- The gold fund manager most outspoken about the evils
of hedging, John Hathaway, sees fiscal distress for many parties as gold
prices rally. Hathaway's Tocqueville Gold Fund has gained 81 percent since
Jan. 2, holding largely unhedged mining companies such as Gold Fields Ltd,
both from South Africa.
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- "There is a huge outcry against hedging among investors,"
says Hathaway. "Mine company managements have received a loud message
from the investment world to cover their hedge books, and all but the most
obtuse will be doing so."
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- Hathaway sees gold mining companies issuing new shares
to buy physical gold that they use to ameliorate, or cover their forward
sales of bullion. "Durban Deep was the first to do it, and I believe
there will be other, bigger players," he said. Durban is a South African
company whose shares have gained 290 percent since Jan. 2.
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- Hathaway estimates each $10 rise in the gold price "means
the collective bullion dealers have extended another $1.4 billion to the
gold mining industry, based on a 4,000-ton position."
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- Hathaway warns, "A $50 move, which is certainly
in the cards, would be $7 billion. What does this mean? It means a serious
squeeze on the bullion dealers, not the mining companies for the most part.
Central bankers who have lent the gold to JP Morgan, Morgan Stanley, Goldman
Sachs and others would not be happy with this situation."
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- What can the bullion dealers do about it? "Not a
whole lot, other than buying gold to cover their short, which is what they
are starting to do," says Hathaway from his Tocqueville offices in
New York City. "Most mining companies, especially the big ones, have
margin-free trading agreements with their various dealers. This means they
do not have to advance cash when the gold price rises. It is too late for
the bullion dealers to go back to the mining companies to change the deal,
so they have no choice."
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- Hathaway sees Wall Street clean-up crews at work, frantic
in their efforts to erase the gold derivatives. "There are all kinds
of crazy, exotic deals made in the past that will come to light -- exploding
puts, knock-in calls, etc., which had high fees originally but are now
viewed as toxic waste by the dealers who sold them."
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- The fund manager points out that actual gold supplies
do not move around as freely as those who need to cover their hedging strategies
would like. "Physical gold is illiquid relative to short covering
demand. This will take gold a lot higher, unless the central banks step
in, which I expect them to do when the gold market gets really disorderly,
like gapping $10-$20 a day or more."
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