GLOBAL GOLD HEDGE BOOK ANALYSIS

Transcription

1 Edition Seven, August 2004 GLOBAL GOLD HEDGE BOOK ANALYSIS Q2 2004

2 Key Points The level of quarterly dehedging increased for a fourth consecutive quarter to reach 3.9 Moz, the single largest measured decline since 2003 Q2. The cut left the total outstanding producer positions, on a delta-adjusted basis, at a provisional 64.2 Moz, equivalent to 77% of annual mine production. The reduction was achieved through a combination of buybacks, book restructuring and delivery into existing committed positions. Newcrest s book restructure had a marked impact on the make up of the global hedge book in Q2. In nominal terms, the company eliminated over 5.0 Moz of option contracts (both vanilla non-vanilla products), which were partly replaced by simple forward sales. Forward sales contracted by 0.9 Moz, whilst vanilla options were reduced by 1.1 Moz and non-vanilla products by 2.0 Moz on a delta-adjusted basis. Composition of the Delta-Adjusted Global Hedge Book (Moz) 04Q1 04Q2 qoq Forwards % Options % Non-Vanilla Products % Total % Note: Totals may not add due to independent rounding. Numbers are provisional and may be revised. At the time of press some companies had not reported their hedge positions whilst in some cases data is only available on a six monthly or annual basis. Net Impact of Producer Hedging Million ounces US$/oz -4 Gold Price -5-6 Q1-00 Q3-00 Q1-01 Q3-01 Q1-02 Q3-02 Q1-03 Q3-03 Q

3 Summary and Overview The delta-adjusted hedge book was cut back by a hefty 3.9 Moz in Q2. The fall represented the single largest quarterly reduction in the outstanding producer positions since 2003 Q2, and also marked the fourth consecutive period of increasing levels of producer de-hedging. The main factor behind the marked decline in the hedge book was a reduction in nominal contract volumes. The delta affect in Q2 was minimal, although a rising delta against the sold calls and sold barrier calls, coupled with a modest reduction in the delta against the purchased puts, left the implied options delta 6% higher quarter-on-quarter. This offset the decline in nominal positions by an estimated 0.4 Moz. Two major hedging events worth mentioning in Q2 were firstly, the AngloGold Ashanti merger, which resulted in the integration of the industry s third and fifth biggest hedge books to create the world s second largest gold hedge book, and secondly, Newcrest s book restructure. Newcrest, holders of the fourth biggest book, completed a major restructure and in so doing eliminated all of its option positions and converted its entire hedge book into simple forward sales (it retained its existing gold loan). Ongoing de-hedging, coupled with a drop in the end period gold price used to value the hedge books ($395.80/oz in Q2 compared to $423.70/oz in Q1), resulted in a modest improvement in the cumulative marked-tomarket for the comparative group of mining companies who report this data. In Q2, the position rallied to a negative $3.7 billion from a negative $5.0 billion in the previous quarter. Realised prices (for all of the companies that report this data) averaged $387/oz, or roughly $6/oz lower than the period average. Prices ranged from a low of $322/oz to a high of $447/oz with just over 60% of mine production delivered at prices lower than spot (see graph on page nine). Producers with hedge books achieved a weighted average price of $385/oz, (close to $8/oz lower than average spot) whilst their unhedged counterparts secured an average of $394 (or $1/oz higher than spot). The gold price tumbled over $50 from the start of quarter through to mid-may. The significant decline was largely due to investor disenchantment stemming from the lack of follow through over the $420 mark, a recovery in the dollar and the inter-action of other commodity prices. The price staged a modest recovery in June, thanks primarily to renewed dollar weakness (in particular against the yen), ongoing Middle Eastern political tensions, and improved physical demand. The three month average price was 4% lower quarter-on-quarter although still 13% higher when compared to the corresponding period in Looking ahead, a detailed analysis of the maturity of the outstanding producer options and forward contracts at the end of the June quarter provides a base case for de-hedging in the second half of the year of 7.0 Moz. This would bring total de-hedging in 2004 to 13.7 Moz, comfortably exceeding the 9.3 Moz cut from the book in In practice, of course, there will be offsetting volumes from both producer buybacks and new hedging, which, on balance, should result in a second half decline of around 5.5 Moz (12.2 Moz for the full year). 3

4 Market Commentary Gold posted a fresh 15 year high in April of $427.25/oz. These heady levels, however, were not sustained with the price tumbling over $50/oz through to mid-may before staging a modest recovery in June, ending the period at $395.80/oz. Year-on-year, the price average for the quarter posted a 13% improvement, whilst compared to the previous quarter it was 4% lower. Much of the price fall was due to waning gold investment demand. April and May were particularly weak with evidence of many paper gold investors closing out positions on a number of exchanges as well as in the OTC market. The chief driver behind investor migration from gold in Q2 was no doubt the disappointing performance of the price itself. Expectations that the yellow metal would continue to push north were not fulfilled and instead a decline to a six month low in May of $375.00/oz was recorded. A slight recovery in June, as investors gradually got used to the idea of a gold price under the $400/oz mark, recovered some of the lost ground, but overall investment demand in Q2 fell short of that witnessed in Q1, let alone the impressive level recorded in the December quarter Net official sector sales amounted to (a provisional) 81 tonnes - the lowest quarterly figure recorded since Member countries of the Central Bank Gold Agreement (CBGA) were the main contributors with sales estimated at 105 tonnes - Switzerland accounted for around 70 tonnes of sales in Q2 with Portugal making up the bulk of the balance. Argentina purchased an estimated 24 tonnes in Q2 and, based on data for April and May, the Philippines bought nine tonnes. Other net buyers of bullion included Mongolia (just less than three tonnes) and Thailand (a little more than one tonne). Comex/Nymex Non-commercial Net Positions Net Positions (Contracts, thousands) Long Gold Price Short US$/oz Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 4

5 Continued producer dehedging during Q2 (an estimated 3.9 Moz) provided the lending market with sufficient liquidity. This maintained the downward pressure on leasing rates, keeping them at historically low levels - similar to those seen in the previous quarter - across all tenors. There was some firming at the short end towards the end of the period - the one month rate, for example, averaged 0.11% in June in comparison to just 0.03% in May and 0.05% in both April and Q1. In contrast, the 12-month rate averaged 0.27% in each month of Q2, figures lower than its Q1 average of 0.30%. Q2 fabrication demand was stronger than had been expected with robust electronics demand in Japan and signals that jewellery demand in both South East Asia (for example Thailand) and the Middle East (for example Turkey) had picked up. Italian jewellery fabrication, meanwhile, seems to have consolidated in Q2 with official bullion imports heading for roughly stable. And in India, Q2 bullion imports are thought to have only dropped modestly year-on-year, despite the high prices, due to optimism over the early arrival of the monsoon and predictions of it proving normal. Mine production is estimated to have declined year-on-year in the three months to June. Lower output in North America, Peru, Indonesia and Australia, amongst others, offset higher reported production in China and a slim improvement recorded in Russian gold production. A part of the drop in output was due to temporary factors - mine production in Indonesia and Australia is expected to recover somewhat in the second half of the year. On the development front, Cambior announced in March that its Rosebel mine in Suriname had achieved commercial production whilst in Russia, Highland Gold, reported the first pour from its 120,000 ounce per annum Darasun deposit. Lease Rates, Monthly Averages 5 4 Leasing Rates (%) month 12 month 1 3-month 0 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 5

6 Sensitivity of the Global Hedge Book The delta-adjusted hedge book was cut in the June quarter by an estimated 3.9 Moz - a 6% decline quarter-on-quarter. The reduction in the global gold book left total outstanding producer positions at the end of Q2 at a provisional 64.2 Moz, a figure 11% lower year-on-year. As highlighted in previous editions of the Global Gold Hedge Book Analysis, the make up of the producer hedge book has undergone a significant shift over the last few years, with the transformation noticeably accelerating over the last 12 months. Ongoing restructuring and the tendency for producers to simplify hedge positions has been the main driver behind the change in the composition of the global book. Simple forward sales, for example, constituted 59% of the nominal global book at the end of 2002, whilst at the end of the June quarter its share had risen to 69%. The concentration of protection in simple forward sales has, of course, been achieved at the expense of both vanilla options and non-vanilla products. In two of the largest book restructures, Barrick converted its sold calls into forward contracts in 2003 Q2, whilst in the current quarter, Newcrest revealed that it had modified its book into simple forward fixed-price sales, having eliminated all of its option contracts. In particular, the effects of the latter restructure had a marked impact on the options element of the global book. Indeed, the non-vanilla products (sold barrier calls and purchased barrier puts and calls) fell in delta-adjusted terms from a position of 3.4 Moz in Q1 to 1.4 Moz in Q2. Here the decline was concentrated in the sold barrier call contracts, which were cut in nominal terms by 2.5 Moz and by a calculated 2.1 Moz in delta-adjusted terms. Sensitivity of Q2 Global Options Book to the Spot Gold Price and US$ interest Rates move in US$ interest rates (basis points) move in gold price Note: the delta-adjusted options book at end-q2 was calculated at Moz. The matrix above tables changes in the delta-adjusted volume under different gold prices and moves in US$ interest rates. 6

7 Concerning the vanilla options position, contracts in nominal terms declined by 3.9 Moz and by 1.1 Moz in delta-adjusted terms. The cut was driven by a decrease in purchased put contracts, which were reduced by 3.6 (nominal) Moz and by 1.1 (delta-adjusted) Moz. Again the Newcrest restructure was a primary factor behind the change - the Australian based producer eliminated 3.1 Moz of purchased puts in Q2 (1.1 Moz in deltaadjusted terms as calculated at the end of the March quarter). Sold call contracts, which make up two thirds of the vanilla options book in nominal terms, were reduced in the second quarter by a modest 0.8 Moz. A 5% increase in the implied delta against these contracts, however, meant that in delta-adjusted terms the quarter-on-quarter decline was somewhat less than this. The sensitivity of the Q2 options element of the global hedge book to movement in the spot price is illustrated in the chart below. On a company basis, the four largest hedge books at end Q2 have been charted against changes in the spot gold price. Post restructuring, Barrick s and Newcrest s books are insensitive to price changes (forward sales have a fixed delta of 1). The situation is different, however, for AngloGold Ashanti and Placer Dome, whose profiles move in a somewhat divergent manner as the price breaches $345/oz. In detail, it is the rising delta against AngloGold Ashanti s large volume of sold calls that drives the response of the profile, whilst, in Placer Dome s case, the primary driver is the declining delta against their considerable volume of purchased puts. The irregular profile of Placer s book to the price is largely due to the presence of non-vanilla products which are more sensitive to price movements. Q2 Options Delta Adjusted Position Sensitivity of the Big 4 Hedge Books End 04Q2 Gold Price (US$395.80) Barrier Options 15 End 04Q2 Gold Price (US$395.80) Barrick AngloGold Million ounces 9 6 Vanilla Options Million ounces 12 9 Placer Dome 3 Newcrest US$/oz US$/oz

8 Company Activity Dehedging in Q2 matched levels last measured in 2003 Q2 when an estimated 3.9 (adjusted) Moz was cut from the global hedge book. Forward sales were scaled back by 0.9 Moz, whilst vanilla options were cut by a significant 3.9 Moz and non-vanilla products (essentially sold barrier calls and bought barrier puts) by a hefty 2.9 Moz in nominal terms. As discussed in detail elsewhere in the report, Newcrest s book restructure accounted for a large part of the reduction in the options portion of the hedge book and also partly explained why the cut in the forward sales was so muted. By way of explanation, the effects of the restructure resulted in an increase in Newcrest s forward position from 4.8 Moz at the end of Q1 to 7.8 Moz as reported at end-q2 (totals include gold loans). This was largely due to the conversion of the company s significant volume of sold barrier call options. Consequently, Newcrest s 2.9 Moz addition to the global forward book considerably offset ongoing de-hedging by, amongst others, Barrick, AngloGold Ashanti and Harmony, who had collectively reduced their forward sale commitments by 2.6 Moz during the quarter. In a global context, there are invariably offsets in any given quarterly period to ongoing dehedging. This counterbalance is provided by new project specific hedging, the extension of existing cover or by the effects of changing deltas. The latter would in turn impact the delta-adjusted volume of hedge positions in response to changes in (amongst other parameters) the gold price, interest rates and volatilities. The table opposite lists the top dehedgers in the June quarter - the share of the decline shown is with respect to the decline in total de-hedging for the quarter, not the net reduction in the global position. To expand, de-hedging in Q2 totalled an estimated 4.6 Moz, whilst new hedging actually added 0.7 Moz to the book, hence the reported net decline in the delta-adjusted hedge book of 3.9 Moz. AngloGold Ashanti made the biggest contribution to de-hedging with a massive 1.1 Moz reduction in its hedge book. The integration of Ashanti s hedge book with Total Nominal Positions, Percentage Change qoq Region Forwards Calls Sold Puts Bought Vanilla Options (net) North America -6% -7% -9% -7% Australia 27% -3% -53% -44% South Africa 46% 16% -2% 17% Other -54% -65% -9% -51% Total -1% -5% -26% -16% Note: Forward sales includes gold loans. 8

9 AngloGold s position during the quarter, created the world s second biggest hedge book at 12.8 (delta-adjusted) Moz, against Barrick s 13.9 Moz. The reduction in the combined book in Q2 was primarily due to a cut in forward sales (AngloGold s forward sale rand contracts alone were reduced from 0.72 Moz to 0.03 Moz). Barrick, meanwhile cut its position by 0.85 Moz. Combined with the cut in Q1, the decline has already exceeded the company s stated target of a 1.5 Moz reduction in the hedge book by the end of Buybacks were an important feature in Q2 with Harmony, Sons of Gwalia and Cambior (and, as mentioned above AngloGold Ashanti) all closing out significant positions. The former eliminated a 0.52 Moz hedge book inherited with the acquisition of Avgold s Target mine. Cambior, which had reduced its book by 0.2 Moz in Q1, made a further cut of 0.28 Moz in the three months to June, leaving the outstanding position at 0.22 Moz, or just four months of mine production. Kinross, Top De-hedgers 2004 Q2 (delta-adusted, spot basis) Company % of decline decline in Moz AngloGold Ashanti 24% 1.10 Barrick Gold 19% 0.85 Avgold* 12% 0.52 Newcrest 9% 0.39 Sons of Gwalia 7% 0.32 Cambior 6% 0.28 Kinross Gold Corporation 4% 0.19 Xstrata** 2% 0.10 Cameco 2% 0.09 Placer Dome 2% 0.08 *acquired by Harmony in Q2 **estimate Note: Delta-adjusted volumes are calculated on the basis of published company data. As such disclosures are not exhaustive, the GFMS calculated position may not exactly correspond to the delta position reported by the company. In addition, 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 reported delta-adjusted volumes. Received Prices in Q2 500 Realised Prices (US$/oz) Q Average Price (US$392.80) 04Q2 Realised Prices 04Q1 Realised Prices Cumulative production (%) 9

10 meanwhile, reported that it had made its final delivery commitment into hedge contracts and was now unhedged and fully leveraged to the spot gold price. New hedging, as mentioned above, totalled 0.7 Moz. However, the bulk of this was attributable to a delta effect against the options contracts, rather than a reflection of any substantial new hedges being put in place. There was, however, some activity worth mentioning (all of which was centred in Australia). Resolute and Dominion, for instance, further built up protection as mining/ development at their respective Ravenswood and Challenger projects progressed, whilst Croesus Mining and copper-gold producer Triako Resources entered into new hedging transactions, adding modest volumes to existing positions. In recent news (10th August), Thistle Mining announced that it had closed out its entire hedge book of around 0.49 Moz of gold contracts. The Canadian based junior first entered into a hedge position as part of the financing requirements of its acquisition of South African based producer, President Steyn in 2002 Q2. At this stage, the contracts primarily consisted of rand denominated purchased puts and dollar denominated contingent forwards. In 2003 Q2, the company announced that it had restructured its hedge book having taken advantage of weak dollar gold prices and a strong rand. In essence, the company closed its (in-the-money) rand puts, securing a healthy premium, and replaced them with dollar denominated forward sales (average contract price $315/oz). The evolution of the gold price and exchange rates, however, moved against these decisions. The average dollar gold price strengthened from $346.90/oz in 2003 Q2 to reach $392.70/oz in 2004 Q2, whilst the average rand:dollar valuation in Q2 appreciated by 14% year-on-year (which would have valued the rand puts at $553.64/oz). Marked-to-Market Gold Hedge Books Delivery Profile End Q2 (base case) US$ billion Mark-to-Market Gold Price (end period) US$/oz Million ounces Non-Vanilla Products Vanilla Options Forwards -6 02Q1 03Q1 03Q2 03Q3 03Q4 04Q1 04Q

11 Technical Annex GFMS has carried out a rigorous analysis of 93 mining companies hedge positions. These companies incorporate the vast majority of those enterprises that carry out some type of hedging activity. The GFMS analysis utilises the Brady Trinity TM Risk Management and Trading system. Each mining company s individual trades have been input into the Brady Trinity system. In terms of the 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 use of the Brady Trinity 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 midpoint of published ranges, where available. Convertible forward contracts are modelled as a barrier call option combined with a vanilla put option. 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 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. 11

12 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 form 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. Delta - The rate of change of the price of a derivative with the price of the underlying asset. 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. 12

13 About Investec Investec is an international, specialist banking group that provides a diverse range of financial products and services to a niche client base, primarily in the United Kingdom and South Africa, as well as other countries including Australia, the United States and Israel. Investec has four principal business divisions, namely Treasury and Specialised Finance, Investment Banking, Private Client Activities and Asset Management. Investec Commodities trades in precious and base metals and provides hedging and structured trades for clients in both the physical and derivatives markets. Based in both the UK and South Africa, they are members of the London Metals Exchange, the London Bullion Market Association and the London Platinum and Palladium Market. They also operate an energy business focussing on structured transactions. About GFMS GFMS Ltd the world s foremost precious metals consultancy, specialising in research into the global gold, silver, platinum and palladium markets. GFMS is based in London, UK, but has representation in Australia, India and Russia, and a vast range of contacts and associates across the world. GFMS is credited with producing the most authoritative surveys of the gold and silver markets, the annual Gold Survey and World Silver Survey, and produces a range of other publications dealing with all aspects of the precious metals markets. GFMS also provides consultancy services in the form of tailor-made research into selected areas of the precious metals markets. GFMS research team of eight full-time analysts comprise qualified and experienced economists and a geologist. On the 27th April, the group released its first Platinum and Palladium Survey. About Brady Trinity TM Brady is a software solutions provider, delivering systems solutions to an international client base of banks and trading organisations. With teams of professionals in the UK, Italy and South Africa, and equity backing from Surecomp International, the company develops and supports its principal product called Trinity. The company s software development is located at its headquarters on the acclaimed Cambridge Science Park in the UK. Copyright August GFMS Ltd 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, GFMS Ltd 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. GFMS Ltd does not accept responsibility for any losses or damages arising directly, or indirectly, from the use of this document. 13