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November was an uneventful month for gold. Since August, gold has been consolidating around the $1,200 per ounce level, and the rout in oil prices that sent WTI crude to 13-month lows of $50 per barrel did not impact gold prices. Gold began the month trending lower to $1,200 per ounce on November 13, then recovered to end the month at $1,222.50 per ounce for a $7.74 (0.6%) gain. Support late in the month came from U.S. Federal Reserve (Fed) comments that the market interpreted as somewhat dovish. Press articles only focused on a small portion of Chairman Jerome Powell’s comments, while the entirety of his speech seemed to suggest that the Fed has not changed its outlook for three interest rate hikes in 2019.
Gold stocks trended sideways with gold in November. The NYSE Arca Gold Miners Index (GDM)1 gained 1.2% and the MVIS Global Junior Gold Miners Index (MVGDXJ)2 declined 2.3%, which indicates that the juniors and mid-tiers were slightly weaker than the senior companies.
Last month the International Monetary Fund (IMF) downgraded its forecast for growth in Europe and emerging markets and suggested conditions have worsened. Germany and Japan experienced negative third quarter GDP growth. As the Fed tightens monetary policies, it is doubtful that the U.S. can remain an island of prosperity. Conditions in housing and autos indicate economic weakness has begun to set in. We believe 2019 is shaping up to be an interesting year for gold as we continue to see signs that the U.S. economic expansion is on its final legs.
The age of hedging has long passed for gold companies. However, we still get questions about hedging from investors and clients. Many remember the scars from hedging strategies that went terribly wrong. Hedging is attractive because gold is almost always in contango, which means the futures and forward prices are almost always higher than the spot price. The forward curve rises as a function of interest rates.
The chart shows gold mining industry hedging activity since 1982. From 1987 to 1999, hedging strategies were a key financial component for most companies. Hedging was originally a way to manage risk. It enabled miners to secure credit and protect revenues from falling gold prices. However, hedging became excessive from 1995 to 1999 as companies increasingly used hedging as a way to speculate on the gold price. It was the answer to a secular bear market in the dotcom boom when gold was regarded as an ancient relic and European central banks were relentlessly selling their gold reserves. To demonstrate the scale of the super-sized hedging, in 1999, 3,091 tonnes (99.3 million ounces) were hedged, compared to global gold mine production of 2,602 tonnes (83.6 million ounces).
The Golden Age of Gold Hedging Has Passed
Net Producer Hedging 1982 through 2018
Source: Reuters GFMS, World Gold Council, VanEck. Data as of November 2018. For illustrative purposes only.
As usually happens when anything is taken to excess, a crash soon followed. In September 1999, European central banks announced an agreement to limit their gold sales to an average of 400 tonnes per year for five years. This announcement caused the price of gold to spike 41% from $255 to $360 per ounce in two weeks. Ashanti Goldfields was a major African producer with operations centered on Ghana. Ashanti held 23 million ounces of reserves and was producing 1.7 million ounces per year with plans to expand to 2 million. The company had built a gold hedge book totaling 11 million ounces. The book was complex because it used derivative arrangements with 17 counterparties or banks. A significant portion of the book was locked into prices below $325, as Ashanti failed to anticipate such a rise in gold prices. When the price rose, the value of the book fell to negative $570 million. This brought margin calls from the banks that totaled $270 million. However, the company did not have the liquidity to post margin. It was effectively bankrupt. Ashanti was ultimately able to work out an arrangement with the banks, but shareholder value was decimated in the process. It took several years for Ashanti to gets its finances in order, and in 2004 the company merged with South African major Anglogold (0% of net assets*).
The Ashanti crash scared the daylights out of every gold company CFO with a hedge book, resulting in the huge decline in hedging from 1999 to 2000. The secular bear market for gold ended in 2001, when a secular gold bull market was heralded in by the dotcom bust and subsequent decline in the U.S. dollar. As the gold price rose, more and more hedge positions that were struck at low gold prices in the 1990s fell underwater. We began avoiding hedged companies in the fund very early in the cycle. By 2007, gold had surpassed $600 per ounce, and some of the heavily hedged majors had books that were billions of dollars in the red. Fearing a continued rise in gold prices, by 2010 companies had bought back virtually all of their underwater hedges at great expense to shareholders.
The next prolonged fall in gold prices came in the cyclical bear market from 2011 to 2015, when the gold price fell from $1,920 to $1,050 per ounce. Through this downturn, hedging was never considered because the industry learned a painful lesson that has not been forgotten. The low levels of hedging shown on the chart since 2010 are again aimed at risk control. Many companies have anti-hedging policies, and those that hedge do so with limitations. There are several circumstances where companies sometimes find hedging a small portion of reserves useful:
Another area where companies have fundamentally changed their financial approach is with debt. As the gold price peaked between 2010 and 2012, the majors financed many of their new projects and expansions with debt. Low post-crisis rates proved irresistible. As the gold price fell to its 2015 lows, many companies were in danger of violating debt covenants. If the gold price had fallen further, some companies would have been in an Ashanti-like situation, lacking the liquidity to service their financial obligations. This close call has caused companies to pare down debt substantially, and most now target net debt of zero or less. Conservative debt policies are necessary in a business where there is no control over pricing and price swings can be volatile. We believe the gold industry is financially sound and stable now, positioned to possibly generate positive returns for shareholders in the next cycle.
IMPORTANT DEFINITIONS AND DISCLOSURES
1NYSE Arca Gold Miners Index (GDMNTR) is a modified market capitalization-weighted index comprised of publicly traded companies involved primarily in the mining for gold.
2MVIS Global Junior Gold Miners Index (MVGDXJTR) is a rules-based, modified market capitalization-weighted, float-adjusted index comprised of a global universe of publicly traded small- and medium-capitalization companies that generate at least 50% of their revenues from gold and/or silver mining, hold real property that has the potential to produce at least 50% of the company’s revenue from gold or silver mining when developed, or primarily invest in gold or silver.
Any indices listed are unmanaged indices and include the reinvestment of all dividends, but do not reflect the payment of transaction costs, advisory fees or expenses that are associated with an investment in a Fund. Certain indices may take into account withholding taxes. An index’s performance is not illustrative of a Fund’s performance. Indices are not securities in which investments can be made.
NYSE Arca Gold Miners Index is a service mark of ICE Data Indices, LLC or its affiliates (“ICE Data”) and has been licensed for use by VanEck Vectors ETF Trust (the “Trust”) in connection with VanEck Vectors Gold Miners ETF (the “Fund”). Neither the Trust nor the Fund is sponsored, endorsed, sold or promoted by ICE Data. ICE Data makes no representations or warranties regarding the Trust or the Fund or the ability of the NYSE Arca Gold Miners Index to track general stock market performance.
ICE DATA MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND HEREBY EXPRESSLY DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE WITH RESPECT TO THE NYSE ARCA GOLD MINERS INDEX OR ANY DATA INCLUDED THEREIN. IN NO EVENT SHALL ICE DATA HAVE ANY LIABILITY FOR ANY SPECIAL, PUNITIVE, INDIRECT, OR CONSEQUENTIAL DAMAGES (INCLUDING LOST PROFITS), EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES.
MVIS Global Junior Gold Miners Index (the “Index”) is the exclusive property of MV Index Solutions GmbH (a wholly owned subsidiary of Van Eck Associates Corporation), which has contracted with Solactive AG to maintain and calculate the Index. Solactive AG uses its best efforts to ensure that the Index is calculated correctly. Irrespective of its obligations towards MV Index Solutions GmbH, Solactive AG has no obligation to point out errors in the Index to third parties. The VanEck Vectors Junior Gold Miners ETF (the “Fund”) is not sponsored, endorsed, sold or promoted by MV Index Solutions GmbH and MV Index Solutions GmbH makes no representation regarding the advisability of investing in the Fund.
Please note that the information herein represents the opinion of the author, but not necessarily those of VanEck, and this opinion may change at any time and from time to time. Non-VanEck proprietary information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Not intended to be a forecast of future events, a guarantee of future results or investment advice. Historical performance is not indicative of future results. Current data may differ from data quoted. Any graphs shown herein are for illustrative purposes only. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission of VanEck.
About VanEck International Investors Gold Fund: You can lose money by investing in the Fund. Any investment in the Fund should be part of an overall investment program, not a complete program. The Fund is subject to the risks associated with concentrating its assets in the gold industry, which can be significantly affected by international economic, monetary and political developments. The Fund’s overall portfolio may decline in value due to developments specific to the gold industry. The Fund’s investments in foreign securities involve risks related to adverse political and economic developments unique to a country or a region, currency fluctuations or controls, and the possibility of arbitrary action by foreign governments, or political, economic or social instability. The Fund is subject to risks associated with investments in Canadian issuers, commodities and commodity-linked derivatives, commodities and commodity-linked derivatives tax, gold-mining industry, derivatives, emerging market securities, foreign currency transactions, foreign securities, other investment companies, management, market, non-diversification, operational, regulatory, small- and medium-capitalization companies and subsidiary risks.
About VanEck Vectors® Gold Miners ETF (GDX®) and VanEck Vectors® Junior Gold Miners ETF (GDXJ®): An investment in the Funds may be subject to risks which include, among others, investing in gold and silver mining companies, Canadian issuers, foreign securities, foreign currency, depositary receipts, small- and medium-capitalization companies, equity securities, market, operational, index tracking, authorized participant concentration, no guarantee of active trading market, trading issues, passive management risk, fund shares trading, premium/discount risk and liquidity of fund shares, non-diversified and concentration risks, all of which may adversely affect the Funds. Foreign investments are subject to risks, which include changes in economic and political conditions, foreign currency fluctuations, changes in foreign regulations, and changes in currency exchange rates which may negatively impact the Funds’ return. Small- and medium-capitalization companies may be subject to elevated risks. The Funds’ assets may be concentrated in a particular sector and may be subject to more risk than investments in a diverse group of sectors.
Diversification does not assure a profit or protect against loss.
Fund shares are not individually redeemable and will be issued and redeemed at their net asset value (NAV) only through certain authorized broker-dealers in large, specified blocks of shares called "creation units" and otherwise can be bought and sold only through exchange trading. Shares may trade at a premium or discount to their NAV in the secondary market. You will incur brokerage expenses when trading Fund shares in the secondary market. Past performance is no guarantee of future results.
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