It's all about the shareholders' wishes, isn't it?
2 June 2011
Sean Russo
ASK the CEO of an unhedged mining company what is the basis of that policy and the answer is nearly always the same: “Shareholders want exposure to the upside in the price of what they produce and hedging gives away the upside”. I have never met one who has polled shareholders on this but invariably they have a fund or two on the register, or promising to join, who actively encourage them not to.
Often it seems to me that there is a stated or implicit threat that should they even think about hedging those funds will exit their register. So for them it’s simple, hedge and their share price will fall or it won't rise as fast as un-hedged guys.
Of course it’s not that simple.
For a start markets don't go up in a straight line and a no-hedging policy conveniently, or at least too lightly, ignores that fact that the flip-side of upside is downside. Interestingly those anti-hedging funds have a policy to protect themselves from the downside. If they see it emerging they sell their stock, or at least some of it. They also have a policy to serve themselves in the scenario that metal prices start deteriorating unexpectedly: it’s short selling the stocks of unhedged miners!
Second, if you are a producer that has costs in any currency other than USD then you have dual exposures to concern yourself with. Given the long-term correlation between metals and the AUD, producers bullish enough to have no metal hedging, and those so bullish that they have no hedging and debt which is doubly risky, should reasonably have used call options to remove their exposure to a rising AUD, which is the well-worn flip-side of their view.
Over the past few years as USD gold prices have risen strongly AUD gold price have basically sat still in a range around $A1400/oz. Obviously where the pace of increase in some of the base metals has not been as great as that of gold the impact of AUD strength has been more detrimental. Australian based producers who have adopted a no-hedging policy on the basis of a noisy fund managers view on USD metal prices have seen no benefit for their higher risk policy.
The Australian dollar has risen in seven of the past nine years. Overseas investors who measure everything back to a USD benchmark have seen this as significantly increasing the USD cost of production of local miners and they are shifting our producers up the cost curve. They are not being singled out; in this regard South African and Brazilian producers know just how they feel but this issue is very important as it is leading to a review of funds’ holdings. Higher up the cost curve and unhedged are not ideal bedfellows so they are looking elsewhere.
More recently AUD strength has spilled over into a double whammy impact on our producers. Not only is AUD seen to be taking the punchbowl away from the party for Aussie producers by making them much less attractive than producers with USD costs or costs in a currency pegged to USD, but their share prices in USD terms simply made it too compelling not to sell. Given most overseas investors in ASX producers don't hedge their currency when they buy they have essentially been short USD while they held AUD denominated shares. In some cases that alone could have made them 10-30% (or more depending on their holding period). In these days of ADHD investing that on its own is worth taking. Add a 20-50% gain on the stock and it's been quite a ride. So regardless of what a company's hedging policy is funds are being true to their own policies, which start with the rule, ‘look after number one’.
That's what we are seeing right now. Despite the fact that AUD metal prices are largely unchanged the share prices of many ASX-listed (and therefore AUD denominated companies) have fallen substantially despite the fact their AUD metal revenues remain unchanged, as does (largely) the outlook for the metals they produce. Overseas investors fear a fall in the AUD will reduce their USD share price gains, if that happens in the context of softer USD metal prices (to which our share prices are more greatly correlated) double-whammy.
Of course this brings me back to the start. Markets don't go up forever. Even markets ‘expected’ to go up don’t go up in a straight line and it goes without saying that when markets expected to go up even just go sideways for a while, that’s disappointing and ADHD fund managers and punters can unexpectedly and quickly retreat to the sidelines as they revise their expectations and re-think their strategies.
This recent share market activity might be a timely reminder for our mining CEOs and CFOs that shareholders sell shares for all sorts of reasons: tax bills, school fees, divorce settlements, to buy house, car or boat, boredom, they change their mind, they find something more interesting to invest in, they can't believe their luck, and sometimes they sell because they determine the prices of the commodities a company produces are more likely to fall.
Of course they don't know where commodity prices are going, nobody does, but they know markets don't go up forever and they don't go up in a straight line. But this does underscore the half-truth in the statement that shareholders want exposure to the metal prices. Of course what they really want is exposure to them going up!
What has to happen to their share prices before management and boards realise that their obligation is to the corporation which endures (hopefully), and not transient but sometimes vocal shareholders?
Recognising there is value in hedging may not always make you popular but do you want to be popular or successful? The last two G J Stokes Memorial Awards were given to David Moore of Mincor and Nick Giorgetta, most recently of Regis Resources and with a long string of exceptional returns for shareholders before that. Both awards were very well deserved given the wealth they have consistently delivered to shareholders. Both those gents have always hedged; ironically they do it because they genuinely have the best interests of shareholders at heart, they know markets can be volatile and they don't view the share market as a handy bank where new cash is only a placement away.
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