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Hedge policies under review

CURRENCY hedging is back in the minds of commodity producers as they watch their margins being eroded with each upward adjustment in the Australian dollar.

Many companies, however, have developed an aversion to hedging, remembering only too well the substantial losses faced by highly hedged businesses when the dollar was on the way down.

Three years ago, a survey by Basis Risk found the majority of companies in the Australian resources sector were hedging at least part of their production against changes in currency or commodity prices. Today, many are still downgrading their hedging position.

Basis Risk director Alan Miller, who provides financial risk management services to WA firms, said these hedge programs were generally aimed at smoothing the volatility of cashflows and/or protecting profits.

“Those companies looking to smooth cashflow volatility were hedging on a continuous basis, while those looking to protect profits would attempt to ‘lock in’ future prices when they appear favourable,” Mr Miller said.

“Often these hedge programs involved the use of complex derivatives.”

An international survey by Gold Fields Mineral Services Ltd released this week shows that companies continue to hold a conservative hedging position against commodity price fluctuations.

The Gold Survey 2002 suggested a contraction in the global producer hedge book of an estimated 147 tonnes during 2001. GFMS director Hester le Roux said this downward trend was likely to continue worldwide.

“The scale and intensity of de-hedging activity in the first few months of 2002 have been impressive, and provided much support for the buoyant gold price,” Ms le Roux said.

“No firm figures are available yet for the first quarter but, based on announcements from Newmont, which is running down the book inherited from Normandy, Harmony, Gold Fields and Durban Roodepoort Deep and several others, we would not be surprised if the net decline exceeded 100 tonnes in the first quarter.”

She said that when miners actively closed-out hedges, rather than just deliver into them, the miner generated a source of demand, as gold has to be purchased in the physical spot market.

At the Fifth International Gold Symposium recently held in Peru, the top three gold mining companies expressed different views on the place hedging has in the current world economic climate.

Barrick and AngloGold both up-hold the value of hedging, believing it is a prudent business measure that allowed more operational flexibility.

And they argued that some certainty in income also provided them with the ability to continue spending money on exploration or acquisitions, even when the commodity prices were low.

However, Newmont maintained its non-hedging stance. It believes hedging serves to protect the production of unprofitable ounces and that accelerated supply from hedging puts downward pressure on the gold price.

Many companies are beginning to favour Newmont’s strategy.

Mr Miller said that, over the past three years, hedging had become a dirty word, as many in the resource sector reported significant losses in their hedging books.

According to Mr Miller, several lessons can be gleaned from these experiences.

“First, there is no evidence that cashflow smoothing in itself adds value to the shareholder,” he said.

“Secondly, companies looking to lock in favourable prices often fail to differentiate between speculating and hedging.

“Third, commodity price and exchange rate hedging cannot be treated as separate issues.”

Objectives such as smoothing cashflows and protecting profits were seen increasingly as inappropriate, Mr Miller said.

“Organisations require broader financial risk management objectives, which are aimed at ensuring the company’s financial position remains sound during periods of adverse market price movements,” he said.

Using gearing measures could provide better indications of a company’s financial position.

Mr Miller said a series of worst-case scenarios of commodity and foreign exchange movements would achieve a stronger tool for management.

“By running scenarios with and without hedging, management may find that gearing can be managed within acceptable limits by a variety of means, such as delaying investments or reducing exploration activities for a short period of time, or by hedging,” he said.

“In fact, given the opportunity cost of hedging, it is often the most costly way of managing risk.

“By developing techniques to compare the impact of hedging with other risk mitigating steps, companies can ensure that they only hedge when they have to.”

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