Hedging—a strategy used to lock in the price at which they can sell their gold in the future—is common among producers of commodities ranging from copper to natural gas seeking to protect themselves from fluctuations in the market. But it has largely fallen out of favor among gold miners after an almost uninterrupted rise in the precious metal’s price over a decade.
One of the benefits of working in the manufacturing industry (in the past) is that you get to spend a lot of time dealing with commodity prices. And you learn a lot about human behavior in the process. Time and time again you see the same behavior. In the face of rising prices, purchasers I dealt with would insist that the price rise was an aberration that would soon fix itself. They would have already reduced price hedges because they were losing too much money and it was impeding margins.
Then after several years of rising prices they would capitulate and begin stockpiling commodities in inventory. They also would start hedging almost 100% of production because the sky high prices were impeding margin. Then, like clockwork, prices would start to fall and they would be sitting on top of lots of purchase agreements to buy commodities at higher prices.
These were all people who got up every day and worked very hard to get their company an edge. I would hire any one of them in a second to run a purchasing organization. The trouble is not one of them ever internalized that when your business is dependent (either long or short) commodities, your hedging program is designed to hedge, not make money. The goal of the program is to stabilize margins…not maximize them.
Regardless of what you think gold prices are going to do from here, I’d be concerned about investing in gold producers, because they are no longer sticking to their knitting.