“Hedging can be valuable if a well considered approach is taken that is both well designed and doesn’t spook investors.”
Global Mining and Metals sector leader,
Ernst & Young
Historically, hedging and price risk management by mining and metals companies has been conducted mainly in an environment of declining prices. After all, why would a miner elect to lock in prices if prices were expected to rise?
Over the past five years, there has been a very strong trend toward mining and metals companies not hedging their production and sales and, in many instances, closing out previous hedge positions. The most notable metal to follow this trend is gold, such that virtually all gold producers have fully de-hedged their metal price exposures.
Paradoxically, hedging and price risk management has been conducted mainly in an environment of declining prices.
The key is to get the timing right
The key challenge to producers is whether they can maximize returns from production over the cycle. Unfortunately this has often meant that miners have hedged at the wrong point in the cycle, when prices were weak, in case prices fell further.
Ideally the time to hedge is when metal prices are near their peak. A good indicator that we are likely to be closer to peak prices than trough prices is determining when prices are trading above their historic trend average, and hence hedging is more likely to produce gains over losses.
This way, a hedging program can provide good underwriting of company profits especially when done at levels that will provide some profitability no matter which direction metal prices move.