Gold’s insiders, and outsiders
Over the past four to five years there has been a stark and growing difference between the way in which Australian and North American gold mining companies sell their gold and manage the associated risks of having high and largely fixed costs, and often high debt, against a totally variable, market driven, revenue line.
In short, the vast majority of North American companies do absolutely nothing about gold price risk management. Indeed they generally promote being totally exposed to price volatility as a virtue. By comparison the number of Australian companies that have forward sold some amount of expected future production, and do so on a regular basis as part of their overall business planning, continues to grow.
On a recent trip to North America, colleagues and I visited a broad cross section of gold producers. We shared with them analysis we had conducted on the changing face of Australian gold producers’ hedge books over the three years 2014-2016. Having seen many Australian companies benefit from increased revenue predictability, in increasingly unpredictable markets, we were keen to understand the reasons for the growing void.
The analysis we shared showed an increasing number of Australian producers were hedging and that most hedging was discretionary and not lender mandated. What took many North American managers by surprise was that our analysis showed that, despite the fact that the Australian dollar gold price has been rising over the three-year period studied, the majority of those producers utilising hedging had achieved better average gold prices than their spot selling peers.
Most had also seen a positive change in the unrealised gains/losses on those positions still outstanding.
That is to say, despite rising prices, most Australian companies that had a higher degree of revenue predictability also generated higher per ounce revenues than their unhedged Australian peers. This largely reflects that the average duration of hedges being entered into are relatively short and companies are regularly renewing cover rather than doing large long-dated structures such as those that were more common in the 1990s and 2000s.
Many North American mining executives that we met said whereas hedging had been a “taboo” subject as recently as two and three years ago, it was now being talked about within management and between management and the board. But looking at company reporting what’s clear is that increased dialogue is not converting to action in all but a few rare circumstances.
Indeed when we queried this difference, between increasing discussion and a lack of observable action, it was almost unanimously met by the response that hedging was rejected by the board because “shareholders are against it”. Many actually ventured that Australian producers must obviously benefit from different shareholders to be “allowed” to hedge as they do.
No one in the North American mining community should imagine that Australian gold producers hear a different message than they do from that cadre of specialist gold share fund managers that actively discourage hedging.
Look at the damage equally meted out to many Australian and North American gold producers by the recent GDXJ debacle. Look at the list of speakers at the key North American gold mining conferences. Indeed, look at the historical messaging on hedging from our largest Australian gold producer Newcrest, which sees itself as more international than Australian; opting to report in USD to be more comparable to its “peers”.
Much of the money flowing into both mining communities is from largely the same sources.
All gold mining management teams and boards have been subjected to the same messaging from those who hold some of the biggest specialist sector purses.
In my opinion and observation the difference that has emerged over the past 4-5 years is that Australian management teams and boards have come to realise that as fiduciaries they have a responsibility to ensure the health of the corporation for all stakeholders. They have heard the concerns of some specialist fund managers that hedging gives up “the upside”. They have also seen those self-same fund managers selling their shares like there was no tomorrow when their own investors started exiting their gold/mining funds.
It’s not that these Australian companies ignore the investor concerns about the possibility of too much hedging possibly being a problem if prices rise dramatically. It’s simply that they have come to realise that they need to pay primary respect to the potential for short term price weakness to undermine their capacity to deliver on their long term business plan. Interestingly, we also hear this is an increasing theme from more generalist investors who are increasingly looking at the improved profitability in the sector but are very concerned by the short term volatility.
No one knows when the next bull market will start but no shareholder will benefit if the business they invested in isn’t around to benefit from it. Equally they will wonder why they bothered if the company has had to high grade and/or issue so much equity to survive that they have lost most of their price leverage along the way.
The type of hedging being undertaken by most Australian companies may not save them if gold prices collapse but in dealing with short term volatility it can give them a platform upon which they can plan with confidence, repay debt on time and in some cases even pay dividends.
What their North American cousins should take note of is that rational investors like managers who behave like owners with a long term vision but razor sharp short term focus. They should also note that they have not been punished in the market place for taking the approach they do.
As we reflected on our meetings we wondered if perhaps it was a cultural difference. Talking about the issue with a friend who runs a large private company for the families of its founders, he gave me a knowing look and pointed me to an incredibly pertinent article in the May/June Harvard Business Review entitled, ‘The Error at the Heart of Corporate Leadership’.
Its central tenant is the company’s health not shareholders wealth, must be management’s primary concern.
This article should be compulsory reading for all managers and directors of gold mining companies, particularly those who reject well-constructed arguments put forward by management teams looking to protect their balance sheets with one liners like, “the equity market will crucify us!”
*Sean Russo is principal of Noah’s Rule, a specialist debt and risk advisor. For more information on the 2014-16 survey on hedging, readers should contact firstname.lastname@example.org