Tumbling gold prices are raising the prospect of a return to hedging – a strategy that has been shunned by investors and producers who spent at least $10-billion at the end of the last decade unwinding forward sales.

“You can’t just stick your head in the sand and pray that gold is going to go back up again,” says Gavin Thomas, CEO of Sydney-based Kingsgate Consolidated, operator of Thailand’s biggest gold mine. He is considering hedging despite investors’ resistance. “Hedging is a call on gold. If you believe it’s going up, you don’t hedge; if you believe it’s going down, you do hedge.”

Petropavlovsk, Russia’s second-largest producer, and Australia’s OceanaGold have begun hedging, and brokers, including Société Générale, are flagging more may follow to bolster revenue and ensure debt servicing, as prices are forecast to extend losses. Gold is heading for its first yearly drop since 2000 and any move towards forward sales of output could accelerate declines, according to Bank Julius Baer & Co.

“The days of being beholden to a religious belief that the gold price will rise are gone – company directors have to be cognisant of that,” says Tim Schroeders, who helps manage $1-billion in equities, including gold companies, at Pengana Capital, in Melbourne, Australia. “There are very few producers who don’t have problems. A lot of them have large debts or high costs. Producers have got to look at hedging,” he says.

Hedging involves mining companies selling future output at fixed prices to secure loans and protect margins. The practice fell out of favour in the past ten years, amid gold’s longest bull run in at least nine decades.

Investors pressured producers to unwind their hedge books as prices soared sevenfold during bullion’s winning streak. AngloGold Ashanti spent $2.6-billion in 2010 to wind up its hedge book, while Barrick Gold, the largest producer, took a $5.6-billion charge in the third quarter of 2009 to eliminate hedging.

“It would be a negative impact on price, the more hedging you see, because what it basically does is to take a stream of gold and sell it into the market,” says Tyler Broda, a London-based analyst at Nomura International, adding that producers already may have missed the chance to lock in prices. “At the top of the cycle, you should have seen mining companies start to hedge.”

Gold, which hit a 34-month low on June 28, is heading for the first yearly drop in 13 years, and Goldman Sachs Group forecasts it will reach $1 050/oz by the end of 2014.

Standard Chartered plc forecasts the net amount of gold hedged will soar more than sixteenfold to 500 t by 2017 from 30 t this year. Fitch Ratings predicted last month that increased royalty sales, forward sales and gold price hedging may occur for less well-capitalised companies.

“If it’s cheaper to hedge than to issue paper at deep discounts, then it makes sense,” Mark Bristow, CEO of Randgold Resources, said in Johannesburg on July 10, adding his company was not against hedging.

A revival of hedging may be a last resort for producers from Toronto to Melbourne who have announced plans to trim spending, sell mines, cut staff and reduce high-cost production in response to a decline in the price of gold that could shave about $10-billion off earnings, according to data compiled by New Jersey-based Kenneth Hoffman at Bloomberg Industries.

Forced to Hedge?

Cutting costs might not be suf- ficient, given the recent accele- ration in the correction of the gold price, and some producers, including Barrick, may be forced to hedge, says Philipp Lienhardt, an analyst at Julius Baer Group.

While hedging made sense in the past for Barrick, the company now has other options, says CEO Jamie Sokalsky.

OceanaGold, a top ten Australian gold miner by market value, said on June 27 it would hedge 111 650 oz of production at its Reefton mine, in New Zealand, over the next two years as the project moves towards care and maintenance.

“It’s just a risk mitigation step – had the gold price stayed up where it was, we wouldn’t have had to do it,” says Mick Wilkes, CEO of the Melbourne-based company. The company does not plan additional hedging, he says.

“With gold dropping from $1 600/oz, you’re starting to hear conversations from producers about hedging,” says Michael Haigh, head of commodities research at Société Générale, who, in April, correctly pre- dicted gold’s rout. It is likely to be the start of a trend, the bank says.

“On the day you put a hedge in, within the next day, it is either the right decision or the wrong decision – it never stays static,” says Peter Bowler, MD of Beadell Resources, which hedged 195 000 oz of gold at $1 600/oz over three years in April 2012 under the terms of a financing agreement. “You go from a hero to zero in this game fairly quickly.”