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Merrill Lynch hammers gold hedging
David McKay
Posted: Mon, 14 Nov 2005

[miningmx.com] -- GOLD price hedging was costly, did not reduce risk for mining companies, and created “a culture of dependency”, said Graham Birch who helps manage Merrill Lynch’s $1bn Gold & General Fund. Instead, gold mining companies should just produce gold as cheaply as possible.

“All I want Bernard [Swanepoel, CEO of Harmony Gold] to do is mine his ore reserves as cheaply as possible because that’s what adds most value to me,” said Birch. “If I want gold price protection, I can do that myself and probably get keener terms.”

Birch was speaking at the London Bullion Market Association (LBMA) conference which debated whether hedging had a role to play for the gold producing industry. A mixture of about 200 bankers, mining industry managers, and businesses in the downstream precious metals industry voted against Birch by a margin of 81% to 19%. Birch was supported in his arguments by Harmony’s Bernard Swanepoel.
Banks are like drug dealers hanging outside schools tempting children
Miners were “bad at hedging” because they did it as the gold price was falling only to reduce the size of their hedge books while the gold price was increasing, said Swanepoel. ”Mining managers can’t be trusted. History shows that we start hedging when the gold price starts to fall,” he said.

Paul Merrick, vice president of the Royal Bank of Canada, said the point of hedging was to lock in protection for the downside while it was still afforable. Merrick, who was arguing in favour of the motion, said there were different degrees and ways of hedging. He was also in favour of “breaking the cycle” when hedging only occured in a bull market.

Merrick was supported by Andy Smith, a partner at Bractea, a precious metals fund in the Ridgefield Capital Group.

Mining companies that hedged: “... benefited from the high gold price when it was going up and got protection on the way down. “If they would just see through the red mist of their evangelical anti-hedging fervour, they would see through this,” Merrick said.

Birch and Swanepoel dealt out some hard criticism for bankers to whom the various hedging strategies were credited. “As soon as a company hedges, it takes away some option value from shareholders with bankers getting something in the middle,” said Birch.

“Banks are like drug dealers hanging outside schools tempting children with crack cocaine,” said Birch. “It creates a culture of dependency where all the profits come from hedging,” he said.

A number of companies ran into financial trouble in the 1990s owing to hedging difficulties including Ashanti Goldfields, Cambior, and Pasminco, an Australian base metals company.
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“A shareholder has never once asked me to hedge, not in 10 years at Harmony. Only bankers have tried to get me to do it,” said Swanepoel. Harmony Gold produces about 3 million oz of gold and while it has not pursued hedging strategies, the company has bought mining assets that were hedged.