Global Hedge Book Analysis Q2-2011

Transcription

1 Global Hedge Book Analysis Q September 2011

2 A PARTNER YOU CAN RELY ON SG CIB s Commodities department is customer relationship-driven and aims at providing the commodities sector with integrated price exposure management solutions. Using its wide array of commodities related services, SG CIB is able to perform in-depth analysis of risks combined with ef cient execution. SG CIB has established itself as a leading player in commodities due to its capacity to provide tailormade global solutions to customers throughout the world. Precious metals With a large choice of references and a wide range of products, Société Générale Corporate & Investment Banking has the answer to most precious metal risk management requirements. Société Générale Corporate & Investment Banking is a member of the LBMA, LPPM and LONDON GOLD FIXING. Société Générale Corporate & Investment Banking Commodities Department provides around the clock competitive quotes for all types of hedging products up to ten years maturities, in US dollars, and all major currencies. Gold Silver Palladium Platinum Société Générale Corporate & Investment Banking provides: spot Market-making as Market-maker of the LBMA (London Bullion Market Association); pricing on Gold Fixings as Member of the London Gold Fixing; swap rates and outright forward prices; deposit rates; metal IRS; options Market-making (Asian, American, and European); forward rate agreements for swap rates, lease rates and metal IRS; exotic options: barrier options, digital options SG CIB has got a long and successful experience with Central Banks servicing and advising 50 of the most active users. A worldwide service Société Générale Corporate & Investment Banking s teams in Paris, London, New York, Sydney and Hong Kong provide services for: producers to hedge future production and nance their projects; central banks to enhance the management of their gold reserves; re ners and consumers to hedge their metal price risks; investors to make the most of market opportunities and broaden their range of risk management products. Société Générale Corporate & Investment Banking dedicated team of Precious Metals research specialists provides: customer tailor-made presentations and direct answers to questions; regular research publications ( , website); daily technical analysis publications. Société Générale is authorised by the Comité des Etablissements de Crédit et des Entreprises d Investissement and regulated by the Financial Services Authority for the conduct of UK business. This document does not constitute, and under no circumstances should it be considered in whole or in part as, an offer, a solicitation, advice or a recommendation to purchase, subscribe for or sell any of the product referred to herein. Any information in this document is purely indicative and has no contractual value. Figures and data displayed in this publication have been drawn from external sources believed to be reliable but which have not been independently veri ed by Société Générale. Société Générale expressly disclaims any liability with respect to the accuracy, completeness or relevance of such data.

3 Contents Key Points 4 Summary and Overview 4 Market Commentary 5 Composition and Sensitivity of the Global Hedge Book 6 Company Activity 7 Outlook 9 Technical Annex 10 Glossary 11 About Thomson Reuters GFMS 12 About Brady plc 12 Copyright Thomson Reuters GFMS - September 2011 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means without the prior written permission of the copyright owner. Brief extracts may be reproduced only for the purpose of criticism or review and provided that they are accompanied by a clear acknowledgement as to their source and the name of the copyright owner. Whilst every effort has been made to ensure the accuracy of the information in this document, Thomson Reuters GFMS cannot guarantee such accuracy. Furthermore, the material contained herewith has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient or organisation. It is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any commodities, securities or related financial instruments. No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness or reliability of the information contained herein. Thomson Reuters GFMS does not accept responsibility for any losses or damages arising directly, or indirectly, from the use of this document. 3

4 Key Points The second quarter saw net hedging again, with 0.19 Moz (6 t) added to the global hedge book. This left the total hedge book standing at 5.07 Moz (158 t) at end-june. This was the second consecutive quarter of net hedging; the last occurrence of consecutive quarters of net hedging was last seen in Alkane Resources was the largest hedger, adding just 0.09 Moz (3 t) of forward sales. In total four companies actively increased their hedge positions. The marked-to-market liability of the global hedge book fell to negative $1.09 billion at end- June. We forecast net hedging of around 1 Moz (32 t) for the full-year; the first time since the hedging crisis that was triggered in Composition of the Delta-Adjusted Global Hedge Book (end-period) Change (Moz) 11.Q1 11.Q2 q-o-q Forwards & Gold Loans % Options % Total % Note: Totals may not add due to independent rounding. Numbers are provisional and may be revised. At the time of going to press, some companies had not reported their hedge positions. In these cases, GFMS have made estimates. Summary and Overview The second quarter of 2011 was notable as being a second consecutive quarter of net hedging, adding 0.19 Moz (6 t), building on a similar amount in the first quarter. Much of this increase was from additions to the options portion of the book and changes in the volume of gold delta hedged against existing option positions, with the total options book growing by 12% quarter-on-quarter. While some producers continued to deliver into and run down hedge positions, there were a limited number of new hedges entered into during the quarter. Most notable of these was Alkane Resources, which entered into a 0.09 Moz (3 t) forward sale to hedge revenue risk relating to Net Impact of Producer Hedging Supply Gold Price (Average, pm fix) Million ounces US$/oz Demand 200 Q1-03 Q3-03 Q1-04 Q3-04 Q1-05 Q3-05 Q1-06 Q3-06 Q1-07 Q1-01Q3-07 Q1-08 Q3-08 Q1-09 Q3-09 Q1-10 Q3-10 Q1-11 4

5 the Tomingley Gold Project, at a strike price of A$1,600/oz. Despite the increase in the end-quarter gold price, used to value the option contracts, the total marked-to-market liability of producer s hedge positions fell, by $152 million. This was because reductions to the book were to contracts which were a greater liability when marked-to market than the newer positions which replaced them, at generally higher strike prices. For the second half of the year, we forecast net hedging again, leaving the total net addition to the global book at around 1 Moz (32 t) for the full-year. This forecast is based both on our expectations on the interplay of hedging/de-hedging and the additional delta-hedging against option contracts, based on our price outlook for the remainder of the year. On this basis 2011 will be the first year of net hedging on an annual basis since 1999; an end to an 11-year hiatus. It would be wrong to assume, however, that general attitudes to hedging amongst the major gold mining companies have changed; in the face of a strongly rising gold price, the pressure is currently still on company management from investors to retain full exposure to rising prices. Market Commentary Gold began the second quarter with a continuation of a rally that had begun at the end of January, rising from a figure of $1,439/oz at end-march to a then high of $1,546.50/oz on the 3rd May (a.m. fix). The increase was fuelled by several factors. Firstly, a continuation of inflation fears, with real interest rates remaining negative among the industrialised economies. Secondly, ongoing fears over sovereign debt fragility, when investors were concerned over the ability of Portugal to finance 9 billion of bond repurchases due in April and June. In addition, tension over unrest in Libya also continued to provide support to the gold price, not only through safe haven buying, but indirectly through its impact on oil prices. Gold then, however, became caught in a wider fall in commodities, dropping rapidly to below $1,500/oz by the 6th May, and remaining mostly rangebound thereafter. Prices settled to a degree as factors towards the end of the quarter were a mix of pro- and anti-gold drivers. For example, Chinese investment cooled somewhat due to normal seasonality, and silver prices collapsed from a high fix of $48.70/oz on the 28th April to $32.50/oz on the 12th May. Even so, safe haven buying continued throughout, as concern grew once again over Greece s financial viability. Evolution of the Global Hedge Book Volume Speculative Net Positions in Comex Futures Million ounces Options Forwards & Loans Net positions (contracts, thousands) Gold Price Comex settlement price (US$/oz) 0 08.Q3 09.Q1 09.Q3 10.Q1 10.Q3 11.Q1 180 Jan Feb March April May June 1300 * Combined non-commercial & non-reportable positions Source: CFTC 5

6 Behind the macro-economic scenario, gold s fundamentals provided key support for the price to be maintained around the $1,500-$1,550/oz level. Central to this was growth in jewellery fabrication, which rose by 12% quarter-on-quarter. While in western markets this figure continued to fall as fabricators moved further to alternative materials in place of gold, and there were price-rise driven fabrication falls in some of the price sensitive markets, the global figure was buoyed by strong demand for jewellery in India and China. Prices (quarterly average) Change 11.Q1 11.Q2 q-o-q US$/oz spot 1, , % US$ 12-mth* 1, , % Euro/kg 32,552 33,687 3% Yen/g 3,667 3,949 8% TL/g % Rps/10g 20,462 21,994 7% Rph/g 396, ,903 5% Rand/kg 311, ,343 6% A$/oz 1, , % Rouble/oz 40,521 42,176 4% * 12 month rolling average Source: Thomson Reuters Scrap supply was also positive for gold, falling by 3% year-on-year, with some depletion of near market stocks, and a reduction in distress selling. However, for both scrap supply and jewellery fabrication, anticipation of higher prices to come led some to withhold scrap sales, and for jewellery buyers to purchase while prices were still seen to be favourable. Another factor behind the quarter s price performance was the continued emergence of official sector buying. Apart from the physical demand generated from these purchases, this activity has been a strong driver of sentiment among investors when news of purchases has emerged, thus exerting much more price influence than its tonnage would impart alone. Composition and Sensitivity of the Global Hedge Book During the second quarter of 2011 the global hedge book grew by 0.19 Moz (6 t) when adjusting for option delta. Both forward sales and the delta-hedging against option positions increased. However, the nominal (number of contracts) volume of the hedge book actually fell in the second quarter, by 0.59 Moz (18 t), as options matured. The contrast between the increase in the delta-adjusted option position and the fall in the overall numbers of option contracts is due to the change in market conditions between end-march and end-june, and its effect on option delta. Implied Underlying Gold Borrowing Rates* Gold ETFs & Other Similar Products % month Moz Gold Price US$/oz month Total ETF Holdings April May June 67.0 Apr May Jun 1400 * LIBOR-GOFO Source: LBMA; Thomson Reuters Source: Thomson Reuters, respective ETF issuers 6

7 Of the options book, the largest change was to sold call contracts. Although the number of sold calls written by mining companies fell by 0.16 Moz (5 t), the amount of gold delta-hedged against them by counterparty banks rose by 0.14 Moz (4 t). Correspondingly the weighted average delta against the sold call contracts rose to 0.4, up from 0.3. This was due to the increase in the endquarter gold price offsetting ongoing deliveries by producers into contracts, leading to an increase in the amount of gold delta-hedged. This effect can be seen in the chart below, which illustrates the sensitivity of the hedge book to changes in gold price, assuming all other conditions remain unchanged. Many of the bought put options on the book have strike prices below $1,000/oz, while the majority of sold call options on the book have strike prices around $1,700-$1,800/ oz. Therefore despite there being more bought puts in total, when adjusted for option delta at end- June sold calls were the dominant contract type regarding the sensitivity of the book; the bought puts were in aggregate further out-of-the-money. In addition, given recent price volatility, and a forecast increase from the end-june gold price, we can expect changes in the delta hedging of existing options, more specifically the sold calls, to have a significant impact on volume of the delta-adjusted book. Q Nominal Hedge Book Composition End-11.Q2 Nominal book volume = Moz Sensitivity of Q2 Options Book as of 30th June Move in Move in Gold Price Volatility (US$/oz) (%) , Brady Plc Note: The matrix above shows the scope for changes in the deltaadjusted volume under different gold prices and volatilities. The delta-adjusted total options book at end-q2 was calculated at 1.42 Moz, based on the end-q2 gold price ($1,505.50/oz) and proprietary Société Générale market rates. Company Activity In the second quarter of companies saw increases to their delta hedge positions. Of this number, only five companies actively increased the number of contracts in their hedge positions; the remainder saw increases due to counterparty delta-hedging of option positions. The largest addition came from Alkane Resources, which entered into 0.09 Moz (3 t) of forward sales against the Tomingley Gold Project. The forward sales will cover the first two and a half years of End-Q2 Delta-Adjusted Position End-11.Q2 Gold Price ($1,505.50) 1.50 Net Put** Forwards & Loans Million Ounces Net Puts Net Calls Net Call* * Sold calls, less bought calls **Bought puts, less sold puts US$/oz 7

8 planned production from the project, at a price floor of A$1,600/oz. In April Simmer & Jack Mines (since acquired by Village Main Reef) entered into a second prepaid forward sale agreement, totalling 0.06 Moz (2 t) payable over 18 months. Regis Resources increased its hedge position by 0.04 Moz (1 t) as part of an extension to a financing facility for the Garden Well Gold Project. This brought the company s total hedge position to 0.20 Moz (6 t). Subsequent to quarter-end, Regis also deferred the delivery dates of a portion of its contracts to match the repayment of the debt facility, which requires repayment by The bulk of the remainder of the hedging which was seen was due to an increase in delta-hedging against existing contracts, which in some instances completely counteracted any reduction in hedging from option maturity. Of these companies, the largest increase was against Sumitomo Metal Mining s position, which we estimate to have increased by 0.08 Moz (3 t). In total we recorded 25 companies which saw a reduction to their hedge position. Looking at the marked-to-market liability of the producer hedge book, this fell in the second quarter, to negative $1.09 billion, a 12% improvement. This was due to the delivery of gold into contracts which carried lower strike prices relative to other contracts on the book, and therefore (generally) a higher marked-to-market liability. Newer hedges, such as those by Alkane Resources and Regis Resources, carry a smaller discount to the end-quarter gold price, used to value the option contracts. Producers realised prices increased by $112/ oz, to $1,457/oz, representing a discount of $49/ oz to the quarter average gold price of $1,506/oz; a broadly similar discount to the first quarter. The increase in realised price in the second quarter Top (De-)Hedging Activity in 11.Q2 (delta-adjusted, spot basis) % of gross: Change Company Hedging (Moz) Alkane Resources 23% 0.09 Sumitomo Metal Mining 21% 0.08 Simmer & Jack Mines 19% 0.07 De-hedging (Moz) Catalpa Resources 2% Teranga Gold Corp 3% Avocet Mining 3% Note: Delta-adjusted volumes are calculated on the basis of published company data. As such disclosures are not exhaustive, the Thomson Reuters GFMS calculated position may not exactly correspond to the delta position reported by the company. In addition, Thomson Reuters GFMS values the contracts on a spot delta basis, whereas some companies report positions on a forward delta basis. This can lead to minor discrepancies between the calculated and delta-adjusted volumes. Where published data was unavailable, an estimate based on the scheduled expiry of contracts has been made. was also broadly in line with the increase in the period average spot price due to the fact there has been relatively little change to the composition of the book from end-march in terms of contracts and strike prices. Outlook Turning to the third quarter, information is already available that several companies have already engaged in additional hedging. Among the Canadian listed companies, Yukon- Nevada Gold Corp entered into a prepaid forward Realised Prices (US$/oz) Realised Prices in Q Q2 Realised Prices (avg. $1,456.95/oz) 11.Q2 Average Price ($1,506.13/oz) Q1 Realised Prices (avg. $1,344.83/oz) Cumulative production (%) 8

9 sale agreement to deliver 0.17 Moz (5 t) of gold over four years. In addition to the $120 million prepayment, Yukon-Nevada will receive on delivery the difference between spot price and $850/ oz, capped at $1,950/oz. The purpose of the facility was to repay issued notes and for capital expenditure relating to the company s Jerritt Canyon property. In addition, Sutter Gold entered into a prepaid facility involving delivery of 0.05 Moz (2 t) of production from the Lincoln gold project. Plus the prepayment, delivery will be made at the price of $941.50/oz. Three Australian companies have added to their hedge positions in the third quarter. Firstly, Ramelius Resources purchased put options covering 0.08 Moz (2 t) of 2012 production from its Mount Magnet development. The options secure a minimum price of A$1,250/oz. Secondly, St Barbara Limited entered into a zero cost collar options structure covering 0.10 Moz (3 t) of production to manage revenue risk from the remaining mine life at Southern Cross. The bought put options secure a minimum price of A$1,550/ oz, and the sold calls cap upside at A$1,610/oz. Thirdly Beadell Resources entered into a forward sales agreement, covering a minimum of 0.12 Moz (4 t) of production as part of a project finance facility for the Tucano gold project. The strike price of the contracts is between $1,500/oz-$1,600/oz. In aggregate, the various new positions already disclosed in the third quarter amount to 0.5 Moz (16 t) of new hedging. Furthermore, the change in gold prices we forecast by end-year, whereby gold could reach $2,000/oz, will influence the level of delta-hedging against option positions on the hedge book. This will have the effect of additional hedging, as sold call options move further towards an in-the-money position, and we estimate that this could account for around 0.64 Moz (20 t) of additional hedging. In the other direction, however, one must consider the effect ongoing deliveries from the book that are due to mature before year-end. The chart below indicates that there is 0.86 Moz (27 t) of de-hedging due by end-2011, and we expect this to somewhat offset the delta hedging of option positions and new hedge positions. However, we believe it is reasonable to assume that further hedging will materialise this year, and combining these four factors in the second half with activity to-date, we forecast net hedging of around 1 Moz (32 t) for the full-year. US$ billion Q1-05 Global Hedge Book Marked-to-Market Marked-to-Market Gold Price (end-period) Q1-06 Q1-07 Q1-08 Q1-09 Q1-10 Q1-11 US$/oz Million ounces Delivery Profile End-11.Q2 (delta-adjusted) Options Net Forwards & Loans *potential de-hedging based on contract year of delivery/expiry 9

10 Technical Annex The Thomson Reuters GFMS analysis utilises the Brady Trinity TM Risk Management and Trading system. Each mining company s individual trades have been input to the Brady Trinity TM system. The use of the Brady Trinity TM system is particularly relevant for the analysis of mining companies options positions. We have entered each option trade by mid-year of expiry. Moreover, non-vanilla products such as convertible forwards have been broken down into their constituent options. This analysis enables us to accurately obtain key parameters and valuations for each instrument used by each company and subsequently for the global hedge book as a whole. This methodology also allows us to model the delivery profile of the hedge book. All forward contracts, including spot deferred, floating rate forwards and fixed rate forwards, are input as forward sales. Options contracts, including cap and floor agreements, are entered as their constituent vanilla put and call contracts. Convertible and contingent options are unbundled into their constituent barrier options contracts. Trigger levels for barrier options are taken as the mid-point of published ranges, where available. Convertible forward contracts are modelled as a barrier call option combined with a vanilla put option. of the trade is 100,000 ounces, the delta volume will be 50,000 ounces (of which the bank will be long). To hedge this exposure, the bank must therefore undertake a transaction that yields an equal and opposite position (i.e. short). This will typically be achieved by the bank borrowing gold (normally from a central bank) and selling this into the spot market. Through this mechanism, mining companies hedging activities impact directly on the spot gold market. It should be borne in mind that the value of an option, as well as the delta, will change in response to movements in key parameters, particularly the spot gold price, but also market volatility, interest rates and time to expiry. In response to this, banks will continuously or dynamically adjust their delta hedge position. In terms of the Thomson Reuters GFMS analysis, the key parameter of interest is the delta-adjusted position. As explained in the glossary, the delta of an option (or indeed of a forward) is the rate of change in the value of the derivative for a change in the price of the underlying. In the case of a gold forward sale (or purchase), the forward delta is 1, whilst in the case of an option, this delta is derived from the Black-Scholes option pricing formula. The counterparties to mining companies hedging activity (typically banks) will dynamically hedge their exposure through delta hedging. For example, suppose a mining company purchases a put option. The writer of the option (a bank) will be long the delta volume. In other words, if the delta of the option is +0.5 and the nominal volume 10

11 Glossary Option - An option contract gives the holder the right, but not the obligation, to buy or sell gold at a predetermined price on or by an agreed date. European Option - An option that can only be exercised at the expiry date. American Option - An option that can be exercised at any time prior to the expiry date. Put Option - An option contract which gives the buyer the right, but not the obligation, to sell a specified amount of gold (or other asset) at a predetermined price (the strike price) on or before a specified date (expiry date). Call Option - An option contract which gives the buyer the right but not the obligation to buy a specified amount of gold (or other asset) at a predetermined price on or before the expiry date. Barrier Option - An option whose outcome depends on the performance of the price of the underlying during the life of the option and whether that price breeches a predetermined barrier. Forward - A transaction in which two parties agree to the purchase and sale of gold at a future date. Gold Lease Rate - The cost of borrowing or return from lending gold, the daily level of which reflects the supply and demand for metal in the lending market. Writer - The writer or grantor is the party who sells the option and receives that premium income. Long - A position in an asset (e.g. gold) for which the value will rise should the price of that asset rise. Short - A position in an asset (e.g. gold) for which the value will fall should the price of that asset rise. Gamma - The rate of change of delta with respect to the asset price. Theta - The rate of change of the price of a derivative with the passage of time. Vega - The rate of change of the price of a derivative with volatility. Rho - The rate of change of the price of a derivative with the interest rate. Greeks - The basket term for the above hedge parameters (delta, theta, vega, gamma, rho). Underlying - Shortened term for the underlying commodity on which forwards and options are traded (i.e. in this case gold). Delta Hedging - A hedging scheme that is designed to make the value of a derivatives portfolio insensitive to small changes in the price of the underlying. Black-Scholes Model - A model for pricing European options. Developed by Fischer Black, Myron Scholes and Robert Merton. See F. Black and M. Scholes The Pricing of Options and Corporate Liabilities Journal of Political Economy 81, 1973 and R.C. Merton Theory of Rational Pricing Bell Journal of Economics and Management Science 4, Vanilla/Non-Vanilla - Vanilla options are simple put and call options, whilst non-vanilla options are more complex, with pay-offs dependant on a variety of market factors, such as price paths or the price of alternative assets. Volatility - A measure of the uncertainty or rate of change of an asset price. Delta - The rate of change of the price of a derivative with the price of the underlying asset. 11

12 About Thomson Reuters GFMS Thomson Reuters GFMS is recognised as one of the world s leading economics consultancies in precious metals, specialising in research into the global gold, silver, platinum and palladium markets. It is also a leading provider of top quality research on base metals and steel. Global Head of Metals Analytics, Philip Klapwijk, and Global Head of Precious Metals, Paul Walker, present regularly at international conferences and seminars on precious metals and commodities and are frequently quoted in the media for their views on the gold, silver and PGMs markets. Thomson Reuters GFMS is credited with producing the most authoritative surveys of the gold and silver markets, the annual Gold Survey and World Silver Survey, and Thomson Reuters GFMS gold and silver supply/demand data forms the global benchmark; the international gold and silver markets are largely dependent on Thomson Reuters GFMS statistics. Thomson Reuters GFMS also produce a range of other publications dealing with all aspects of the precious metals markets, and provide consultancy services in the form of tailor-made research into selected areas of the precious metals markets. About Brady plc Brady provides the leading trading and risk management software for global commodity markets. On a single platform, Brady provides complete integrated solutions supporting entire commodities trading operations, from capture of financial and physical trading, through risk management, to handling physical operations to back office financials and treasury settlement. Brady has more than 25 years of expertise and more than 150 customers across the five continents, including some of the largest financial institutions and mining corporations who depend on Brady s software solutions to deliver mission critical business transactions across their global networks. Brady is headquartered in Cambridge with offices in London, New York, Geneva, Bergen, Oslo, Singapore, Paris, Amsterdam and Philadelphia. 12

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