Gold Mining Hedging Instruments

Question: Discuss about the Gold Mining Hedging Instruments. Answer: The gold mining companies selling their commodity in the country of India is exposed to mainly three types of risks which are as follows: Commodity Price Risk Foreign Exchange Rate Risk Interest Rate Risk The risk of the commodity prices is somewhat equal to the risk of the gold prices, which is the change in the prices of gold. This affects the values of the assets, profitability f the operations and the cash flows that are generated from those operations. These affect the companies that are involved in the process of gold mining (Greenbaum, 2011) The prices of the gold is affected by a number of different factors which are as follows: Demand that exists for the gold in both the jewellery and also in the uses in the companies and in the industries The international, regional, political and the economic trends that exists in the country The relative strength of the US dollars of the other currencies The expectations of the financial market The activities that are included in the speculation The amount of the reserves that the company has The forward sale of the company The production and the level of cost of the gold (Fang et al, 2017) In respect of the risk in the foreign exchange, there is a change in the values of the currencies of both the countries that are involved. The companies have their mining operations, activities along with the investments outside the countries since they do not know the place wherein the ore bodies are embedded. Hence, the revenues and the costs are entered into in the foreign currency. The negative movement of the company would affect the cash flows, profitability of the company (Fang, 2017). In respect of the risk of the interest rate, it affects the cash balance the amounts of the borrowings, the long term debts, the hedging activities, the return on the assets and the value of the firm. There is a reduction in the rate of the interest and also an increase in the lease rates of the gold that has an adverse impact on the price of the contract of the new gold and also on the difference that exists between the price of the gold and also in the current spot price. An effective management of the risk for all of the gold mining companies depends on the decisions and the strategies that are adopted by the company for the purposes of risk management. The techniques and the products that the gold producers could use includes the future contracts, gold loans, spot deferred contracts, forward sales of the gold, gold swaps and the put options for the purposes of hedging themselves as against the exposures (Betts, 2017). The companies could also use the derivatives for the gold price risk such as the forward contacts, spot deferred contract, put and call option and the gold lease rate swaps. The most common used forward contracts as being the hedging instruments are due to the introduction of SFAS no. 133/138. This allows the producers of the gold not to consider their sales contracts as the instruments of the derivatives as long as the same are considered to be the normal sales. The gold mining companies could also record the proceeds under the stated contract as revenue and could also be held off the financial statement unless and until they mature. Also, unless and until the date of the delivery approaches of the gold in the future. The gold mining companies also use currency forwards and currency options. Due to the fact that the gold is quoted and also traded in US dollars, the gold producers with the operations and the investment are very much large in number and in respect of the countries that are outside the US and hence, would be exposed to the risks of the foreign exchange rate. The gold mining companies also use the medium to the long term horizon interest rate swap. The risk of the interest rates are also seen as one of the most important things as the risk of the gold prices along with the currency are due to the low leverage in the industry of the gold mining. Hence, in the nutshell, the following could be used as hedging instruments: Currency forwards Currency options Forward contracts Spot deferred contract Put and call option Gold lease rate swaps Future Contacts Gold loan Gold Swaps Spot deferred contract Forward sales of gold Put options (Insurance purpose) References: apmr.management.ncku.edu.tw. (2017).Optimal Hedging Decisions for Gold Miners: How Much Future Production Should a Gold Miner Forward Sell?. [online] Available at: https://apmr.management.ncku.edu.tw/comm/upfile/File0806111163.pdf [Accessed 9 May 2017]. Open.uct.ac.za. (2011).The use of derivatives in the mining sector: a comparative analysis of companies listed in South Africa, Australia and the UK. [online] Available at: https://open.uct.ac.za/bitstream/item/10774/thesis_com_2011_greenbaum_m.pdf?sequence=1 [Accessed 9 May 2017]. pdfs.semanticscholar.org. (2017).An Empirical Study of Derivatives Usage in the Australian Gold Mining Industry.. [online] Available at: https://pdfs.semanticscholar.org/909c/91f51b4ecec6bde0fa3082fd0ef0fe384bea.pdf [Accessed 9 May 2017]. www.mssanz.org.au. (2017).Hedging financial stress. [online] Available at: https://www.mssanz.org.au/MODSIM01/Vol%203/Fang.pdf [Accessed 9 May 2017].