[miningmx.com] – AMONG the more inscrutable areas of the gold industry, the words contango and its alter ego, backwardation, rate highly, especially for the onlooker.
The point of mentioning them is that earlier this month, the gold market was briefly in backwardation. It’s worth pointing it out because it almost never happens.
Backwardation happens when the cost of leasing gold is more than the potential gain of selling it forward. Normally, gold traders like to lease gold at about 0.25% or 0.5% interest, sell it forward, and pocket the cash that, reinvested, attracts interest of 2% or 2.5%. That’s a contango.
According to William Tankard, a research director at Thomson Reuters GFMS, the existence of backwardation means there’s very little gold to be found for speculative purposes. This is partly informed by demand for physical gold because the price of gold is about a quarter cheaper than it was a year ago.
But it’s mostly the result of short-covering. In other words, traders earlier this month were buying gold in order to protect themselves should their extremely bearish views on the gold price not materialise, or the market had run down far enough.
It proved to be a good move, one suspects, since the price of gold has travelled about $120 per ounce from just below $1,220/oz to $1,340/oz in the last few days.
It’s an environment that is not safe to navigate for anyone less than expert traders, but it does suggest gold has new support around $1,130/oz, according to a recent report by Standard Bank Commodities in London.
The gold market remains highly volatile. This, in turn, makes life difficult for gold companies who are having to think about basing their financial plans on a different gold price assumption, but what? And at what rand?
In this context of heightened volatility, could the dark art of hedging the price of gold make something of a minor comeback?
Hedging gold – effectively selling it forward in a contract so as to lock in a certain level of revenue – was all the rage in the Nineties. Unfortunately, gold producers couldn’t predict when the gold price would increase and when it did, found themselves selling their product at levels far below the spot price.
This made for red faces all round; not to mention, provoking the profound irritation of shareholders who stood confounded by massive opportunity costs.
So exotic were some hedge books that companies foundered when the gold price rose. Ashanti Goldfields, the Ghanaian company, was forced to merge with AngloGold because of its wreckless hedging strategy.
“We probably will see some hedging,’ said Tankard. “Whether it will approach what we saw between 1996 and 1999, I doubt it,’ he added.
