Hedge/Hedging

The strategy of price risk management by entering into contracts that balance each other out or protect from sudden price fluctuations; the main raison d’être of forward sales, futures and options is for such protection.

Hedging may be undertaken by a mining company selling output forward or writing put options to protect against a price fall, or a fabricator who will need gold in six months buying a futures contract or call option to insure against a price rise. Hedging, in short, is all about financial engineering as insulation from the variable winds of the market.

Hedging techniques using the futures and options markets became extremely sophisticated during the 1990s but in September 1999 a number of hedged mining companies found themselves in difficulties when the gold price rallied (in the wake of the European Central Banks' Gold Agreement) contrary to their expectations.

Ashanti Goldfields of Ghana and Cambior of Canada were particularly seriously affected, the former by margin obligations that exceeded its available liquidity and the latter by physical delivery demands far beyond its quarterly production. Both companies were eventually saved from disaster but at huge cost to their assets. Other producers took note and restructured their hedging books along much simpler lines or in a few cases, got out of hedging altogether.