Hedging, a form of security against falling future prices, is a process whereby miners and other suppliers of metal can guarantee the future profitability of their operations by locking in currently prevailing prices.
But there is a downside – for the miner, a forward sale in a rising market makes little sense. The forward price is normally very close to the currently prevailing price; if prices rise by much, a miner would still have to deliver at the agreed rate, foregoing the increased profit margin.
Hedging also tends to force down near-term prices for everyone, including hedgers and non-hedgers.
The practice was in its heyday in the 1980s and 1990s, with most gold producers selling large swathes of their production forward – meaning they guaranteed to sell at the current price, with the party on the other side of the deal – normally a market-making bullion bank – guaranteeing to buy.
It has since fallen out of favour after producers and stock holders saw potential profits slip away when the market embarked on a bull run since 2000.
A further risk comes from inflation. Mining operations that are profitable at current rates may not be so if wage rates rise while the income generated per ounce remains stable – this is something that is normally addressed naturally because gold is an inflation hedge and rises when inflation rises. But if future sale prices were already agreed, this balance is disturbed.
Nevertheless, when gold returned to a bear market – after peaking at $1,921 per ounce in 2011, it fell to $1,180 by the end of 2013 – some in the market were predicting that hedging would make a comeback.
There has been little evidence of this, however – miners were still net dehedgers into late 2013.