Source: Zhitong Finance "Since 1950, the S&P 500 index has risen more than 10% 21 times as of the end of May. In about 90% of these cases, the S&P 500 index rose for the rest of the year. There were only two instances of declines for the rest of the year, in 1987 (-13%) and 1986 (-0.1%)." With the rebound of the stock market, the old adage "Sell in May and Go Away" seems to have been a bad advice once again. Last month, the S&P 500 index rose 4.8%, the best May performance since 2009. The NASDAQ 100 index rose nearly 6.2%, and the NASDAQ Composite Index rose 6.9%. Goldman Sachs FICC & Equities Trading Division said: "History doesn't really support this saying. Don't sell, leave the market (go on vacation), and enjoy the good times." The rising trend is still to be continued? If history is any guide, it may indicate that the rise of the stock market is not over yet. Looking ahead to the rest of 2024, Scott Rubner, Managing Director of the Goldman Sachs Global Markets Division and tactical expert, pointed out the following historical background for investors. Rubner stated that the S&P 500 index has risen 10.7% year-to-date, and since 1950, the S&P 500 index has risen more than 10% 21 times as of the end of May. In about 90% of these cases, the S&P 500 index rose for the rest of the year. There were only two instances of declines for the rest of the year, in 1987 (-13%) and 1986 (-0.1%). "Since 1950, the median return of the last 7 months of each year (June 1 to December 31) is 5.4%. In the aforementioned 21 cases, the average performance of the last 7 months increased to 8.1%." Rubner added. Rubner also pointed out that the NASDAQ index has risen for 16 consecutive Julys, with an average return of about 4.64%.

According to MetalsFocus, although hedging positions can be used to protect cash flow for gold producers during periods of low gold prices, they may also become liabilities during periods of rising gold prices. Looking to the future, if gold prices continue to rise, a significant portion of current hedging positions will become liabilities for companies, and rolling over or settling some or all of hedging contracts will become a more common occurrence.

In 2023, the rise in gold prices to a record high prompted gold producers to initiate a U-shaped reversal in their hedging activities. After net divestment for three consecutive years, gold producers quickly turned to net increase of hedging positions, resulting in a year-on-year increase of 67 tons in their hedging positions. By the end of 2023, the total hedging position adjusted by Delta was raised to 238 tons, the highest annual increase since 2014. Producers engaged in hedging activities, especially Australian mining companies, took advantage of the favorable timing of gold futures premiums over spot prices, which in some cases not only increased hedging positions, but also extended the duration of existing positions from the usual two years to three or four years.

For many gold producers, hedging is seen as a beneficial operation that can ensure future cash flow during the production and operation process, especially during periods of high capital expenditure. However, for some producers, hedging can also become a liability, which has a negative impact on the company's cash flow and may even affect the feasibility of projects in some cases.

Mining companies carry out hedging activities for various reasons, with the most common being to safeguard cash flow. However, for small and medium-sized mining companies whose projects are still in the development stage, entering into hedging contracts is usually a necessary condition for them to obtain debt financing for project construction and production. Generally speaking, hedging activities can have positive or negative impacts on the company's cash flow at the start of gold production, depending on the trend of gold prices. If the gold price is rising, hedging activities can provide a premium for spot prices during periods of low gold prices, but if the gold price is falling, mining companies may not be able to sell part of their production at spot prices when they are higher than the exercise price.

Global Delta-adjusted hedging book

Metals Focus

57% of the total hedging position of gold producers is linked to debt financing, with many hedging contracts having an exercise price far below the current spot price. Data for the first quarter of 2024 showed that the weighted average exercise price of forward contracts was $1,940 per ounce, $274 lower than the spot price of $2,214 per ounce at the end of the first quarter. Forward contracts accounted for 70% of the total hedging position at the end of the first quarter, covering gold production for producers until the end of 2027.

The remaining portion of the total hedging position is option contracts, covering gold production for producers until 2031. The weighted average exercise price of purchased put options is $1,868 per ounce, which is $346 lower than the spot price. In fact, as of the end of the first quarter of 2024, only 3% of purchased put options were in-the-money options, or options with intrinsic value. The weighted average exercise price of sold call options is $2,141 per ounce, which is $74 lower than the spot price. Compared with purchased put options, 41% of sold call options are in-the-money options, with profit opportunities.

In recent months, different consequences have arisen when the contract exercise price is lower than the spot price. In order to develop its Magino mine project in Canada, in 2022, Argonaut Gold Ltd. entered into a loan financing agreement totaling $0.25 billion, including forward contracts with a weighted average exercise price of $1,836 per ounce, which was considered favorable at the time. However, by the fourth quarter of 2023, when Magino mine announced the start of commercial production, the exercise price was $141 per ounce lower than the spot gold price for the quarter. These forward contracts cover part of the gold production until 2026 and may still be a liability for the company even if the spot price may fall before then.

Following its recent acquisition of Argonaut Gold Ltd., Alamos Gold Inc. settled forward contracts covering production in 2024 and 2025, totaling 0.1794 million ounces. As a result, Alamos signed a gold prepayment agreement based on a forward price of $2,524 per ounce to receive a $116 million prepayment for 0.0494 million ounces of gold to be delivered in 2025. The corresponding hedging position of Argonaut Gold dropped to 0.15 million ounces, covering production until 2026 and 2027, making its hedging position far more advantageous.

In 2019, Capricorn Metal signed a loan and financing agreement worth up to AUD 0.1 billion for the Karlawinda mining project in Australia, which includes forward contracts covering gold production of 0.2 million ounces from the second quarter of 2021 to the third quarter of 2025, with an average exercise price of AUD 2,237 per ounce, as a mandatory condition. Due to the strong growth in output after the mining project starts production in 2022, the loan provider agreed to modify the loan agreement and roll over the forward contracts to 2025 and 2026. Although the arrangement seemed favorable at the time, Capricorn partly settled the forward contracts later. In the second quarter of 2024, the company settled forward contracts covering the production of 0.052 million ounces, with an average exercise price of AUD 2,237 per ounce, and replaced them with options to buy put contracts covering the production of 0.052 million ounces, with an average exercise price of AUD 3,432 per ounce. Capricorn spent AUD 69.6 million on this, but it enabled the company to reap greater benefits from rising gold prices.

Composition of hedge hedging books

Metals Focus

Why hedging has become a liability for gold producers, Calidus Resources is an even more extreme example. The Warrawoona mining project in Australia is Calidus' flagship project. In 2020, a loan and financing agreement worth AUD 0.11 billion was reached to develop the mine, one of the conditions of which was to hedge 0.125 million ounces of gold production at an average exercise price of AUD 2,355 per ounce. However, when the mine announced the start of commercial production in the first quarter of 2023, the exercise price was about AUD 400 per ounce lower than the spot price. The company incurred losses from hedging positions every quarter in 2023, and the total maintenance cost increased rapidly. Meanwhile, the area where higher-grade ore can be mined is limited. In the third quarter of 2024, the company entered bankruptcy, and hedging losses may have been an important reason.

In the current high gold price environment, it is not only small and medium-sized gold producers that will incur hedging liabilities. According to a report in the first quarter of 2024, larger producers such as Coeur Mining, Eldorado Gold, and Endeavor Mining incurred fair value liabilities of USD 7.9 million, USD 10.2 million, and USD 47.5 million, respectively, due to their gold hedging positions. To limit the negative impact of hedging contracts on cash flows, these companies have set strict limits on the maximum amount of hedging permitted for a single event. In addition, it is said that elephants never forget, and investors will not forget the history of gold producers engaging in hedging. Although the days when gold mining companies held hedging positions worth USD 1 billion are long gone, investors' aversion to mining companies engaging in hedging operations persists, which will also affect the amount of hedging positions held by gold mining companies.

Weighted average exercise price and gold price in the first quarter of 2024

Data source: Metals Focus