Table: Gold prices versus the Philadelphia Stock Exchange (PHLX) and AMEX Gold Basket of Unhedged Gold Stocks Index (HUI)
The DNA of the CFO wheel
“Current global issues will fuel uncertainty and therefore volatility. Successful miners will be those that recognize and exploit value from volatility.”Jay Patel
Transactions Partner, Canadian Mining and Metals, Ernst & Young
Equity markets are becoming increasingly sensitive to macroeconomic news, and for many organizations increases in commodity prices are often not fully impacting share prices, whereas decreases are.
The erosion of the gold premium is a prime example. This is creating differing asset valuation expectations, impacting the ability to complete transactions.
The equities market has also not kept pace with metals prices. This is perhaps mirrored by a lack of investor confidence in short term market stability.
Companies’ operating costs are often not in their functional currency, and therefore volatility in foreign exchange prices can put extreme pressure on them.
To combat this volatility, mining and metals companies need to consider metals price and currency hedging strategies, and hedging inputs to production.
Scenario planning could help them assess their ability to withstand price shocks and capitalize on the current metal price cycle.
During periods of great volatility, mining and metals companies need flexibility to vary the level of production.
Dynamic Discounted Cash Flow (DCF) and Real Option (RO) modelling are providing decision-makers with enhanced cash flow models that improve risk assessment and financing options of mining projects.
Only a handful of mining and metals companies are, however, implementing these techniques and generally seem to be battling with scenario planning. We expect to see increasing board level focus on currency and metal price volatility strategy and management as they strive to recognize and exploit value from volatility.
Steps mining and metals companies can take to respond to this risk: |
| Identify sources of volatility that can be effectively managed — input prices, currencies and metal prices |
| Pursue hedging strategies to reduce currency and inputs volatility to maintain predictable cash flow |
| Increase flexibility in operations and measure the benefits |
| Undertake planning under various scenarios, even at a high level, to assess the ability to withstand price shocks and the ability to capitalize on the current metal price cycle |
| Put in place and maintain adequate liquidity arrangements for downside protection |
| Reassess hedging as a strategy to ensure financial performance no matter the direction of metal prices |
| Maintain a focus on costs and containing costs |
| Exercise prudence in capital allocation and performing stress testing with extreme price assumptions |
| Diversify metal portfolio and jurisdictions to mitigate the impact of a fall in prices of various metals and currency effects on local costs |
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