Forward selling dulls gold’s volatility

One of the most hotly debated investment topics in recent weeks has been the question of why gold bullion failed to stage a dramatic rally in the wake of the Kuwait crisis. Gold, traditionally a barometer of political and economic instability, exhibited only a lacklustre rally on the back of the Kuwait crisis, while oil prices more than doubled. The yellow metal briefly spiked above US$400 per oz. in August after Iraq invaded Kuwait, but it has recently fallen back to US$384 per oz. in London

One explanation for gold’s dull performance is offered by mining analysts at Barclays de Zoete Wedd. They say aggressive forward selling by producers during third quarter dulled gold’s response to the Gulf crisis.

“In the third quarter alone, producers sold forward 5.1 million oz. of gold bullion, equivalent to 9% of estimated world production,” says Barclays.

“Producers have become active forward sellers at US$400 but are absent at US$360, helping keep gold prices in a narrow trading range.”

World bullion markets had not previously experienced such a high degree of willingness by producers to take advantage of gold price spikes, notes Barclays.

Selling forward is just one of several “hedging” strategies used by the world’s major gold producers to lock in cash flow and take advantage of high gold prices.

South African producers have only just begun to build hedge positions, while North American producers have aggressively bolstered their hedge positions in the third quarter.

LAC Minerals (TSE), for instance, has hedged about 24.2% of its gold reserves, while American Barrick (TSE) and Amax Gold (TSE) have hedged just over 19% of their reserves. Unhedged companies include Battle Mountain (TSE), Homestake (NYSE) and Newmont Gold (NYSE). Australian gold miners are by far the largest hedgers with more than 50% of their reserves hedged.

But the world trend toward an increase in hedged positions has had a negative effect on gold prices, say analysts at Barclays.

“Observers seem to have missed the importance of producers in influencing prices in the bullion market.”

Producers are now showing an increased desire to hedge their production and abundant strategies are available to them including options, forward contracts as well as gold loans.

According to Barclays, the total amount of gold hedged at the end of the third quarter increased by about 70% of estimated 1991 production, or to about 9.9% of total reserves. This represents the most extensive hedge position producers have ever established, says Barclays.

Since the degree of producer influence on bullion markets has steadily increased, they now have a major impact on any rallies in the gold price.