A hedging program can make sense for a gold producer, but hedging is something that — with a small number of exceptions — gold producers should never do. This is not because there will always be a direct cost or an opportunity cost associated with any hedging program, it’s because gold producers are so damn bad at it.

In order to optimise cash flow and make short-term financial performance more predictable, it will generally make sense for a gold producer to forward-sell some of its future production, either via a bullion bank or the futures market, after a run-up in the gold price to near a 6-month high. Provided that the total amount forward sold never exceeds more than half of the next 12 months of production, this type of hedging program would always smooth cash flows and would often increase cash flows. It would create an opportunity cost in a very strong gold market, but the cost would not be substantial because all production beyond the coming 12 months would remain unhedged.

However, gold-mining executives have proved over and over again that when it comes to the timing of their hedging moves, they are the proverbial dumb money. They get scared and put hedges in place following a large price decline and then get pressured into removing the hedges at great cost following a large price rise.

In other words, rather than locking-in relatively high prices for a portion of future production by hedging when the market is ‘overbought’, if they hedge at all it is usually when the market is ‘oversold’. Consequently, their hedges tend to lock-in relatively low prices for a portion of future production.

And it’s not just the hedging of future sales that gold-mining executives routinely make a mess of. They are usually just as bad when it comes to hedging their costs. For one example, Barrick Gold chose to mitigate the risk of future gains in the oil price by purchasing some oil production, the idea being that what its gold-mining business lost due to a higher oil price would be partially offset by increased profits from the oil business. The problem is that it made the purchase in mid-2008 — right at the secular peak for the oil price. For another example, the senior management of Gold Fields (GFI) implemented a hedging program covering the bulk of the company’s oil exposure through to the end of 2015. The problem is that the program was put into place just prior to last year’s oil price crash and therefore prevents GFI shareholders from obtaining any benefit from the lower oil price this year.

When trading or investing it is of vital importance to acknowledge your own weaknesses. For example, there is no shame in being a poor short-term trader provided that in recognition of this reality you risk very little money on short-term trades. Gold mining executives should acknowledge that they are hopeless at hedging and should stop trying to do it.

I have never been in the camp that exclaims “buy gold because the US is headed for hyperinflation!”. Instead, at every step along the way since the inauguration of the TSI web site in 2000 my view has been that the probability of the US experiencing hyperinflation within the next 2 years — on matters such as this there is no point trying to look ahead more than 2 years — is close to zero. That is still my view. In other words, I think that the US has a roughly 0% probability of experiencing hyperinflation within the next 2 years. Furthermore, at no time over the past 15 years have I suggested being ‘long’ gold due to the prospect of a rapid rise in the CPI. This is partly because at no time during this period, including the present, has a rapid rise in the CPI seemed like a high-probability intermediate-term outcome, but it is mainly because gold has never been and is never likely to be a play on “CPI inflation”.

Gold is a play on the economic weakness caused by bad policy and on declining confidence in the banking establishment (led by the Fed in the US). That’s why cyclical gold bull markets are invariably born of banking/financial crisis and/or recession, and why a cyclical gold bull market is more likely to begin amidst rising deflation fear than rising inflation fear.

There are times when the declining economic/monetary confidence that boosts the investment demand for gold is linked to expectations of a rapid increase in “price inflation”, but it certainly doesn’t have to be. For example, the entire run-up in the gold price from its 2001 bottom to its 2011 peak had nothing to do with the CPI. Also, an increase in the rate of “CPI inflation” would only ever be bullish for gold to the extent that it brought about declining confidence in the economy or the banking establishment, as indicated by credit spreads, real interest rates, the BKX/SPX ratio and the yield curve. Since it’s possible for the CPI to accelerate upward without a significant decline in confidence, it’s possible that an upward acceleration in the CPI would not be bullish for gold.

The bottom line is that as far as the gold market is concerned, the CPI is more of a distraction than a driver. 

The US$ gold price has essentially gone nowhere in a boring way over the past 2 weeks, which probably means that a sharp 1-3 week move is about to start. The question is: In which direction?

Obviously, no one knows the answer to this question. The most we can do is look for clues in the price action.

On the minus side, gold closed below its 20-day moving average (MA) on Monday 20th April. This was the first daily close below this MA since mid-March and in isolation would be a sign that the price was rolling over to the downside. On the plus side, however, the price managed to hold at the 50-day MA on Monday. More importantly, the gold-stock indices made small gains despite an $8 decline in the gold price. This small bullish divergence between the bullion and the mining stocks tilts the odds in favour of the next $30+ move being to the upside.

Here are the relevant charts:

1. The first chart shows that gold has near-term resistance at $1210. A daily close above $1210 would suggest that the price was headed to at least $1230 and possibly as high as the $1280s.

2. The next chart shows that the HUI has managed to hold last week’s minor upside breakout, but has more resistance at 180. There is near-term (1-3 week) upside potential to 195.

3. The final chart paints the most bullish picture.

Gold’s true fundamentals (the fundamentals that many gold bulls studiously ignore as they instead choose to fixate on irrelevancies such as the amount of gold being imported by China) are neutral and gold/euro does not yet appear to be close to completing the intermediate-term correction from its January-2015 ‘overbought’ extreme, so the start of a major gold rally is probably not imminent. In other words, if the recent choppy price action leads to a quick advance over the next couple of weeks it probably won’t mean that we’ve seen the last opportunity to buy gold below $1200.

There’s an old saying that goes something like: If you owe the bank $100K and you can’t pay then you have a problem, but if you owe the bank $100M and you can’t pay then the bank has a problem. This saying applies to the current negotiations between the Greek government and the other euro-zone (EZ) governments regarding the Greek government’s ability to obtain additional support from its official-sector creditors. In particular, it explains why the governments of Germany, France, Italy, Spain, etc. are very keen for Greece to remain part of the EZ.

The following table shows the official-sector EZ exposure to Greek government debt. More specifically, the table shows the direct and indirect (via supranational organisations) financial exposure of each EZ member state to the bonds issued by Greece’s government. Total exposure amounts to about 330B euros, with individual exposure typically being in the 3%-4% of GDP range. In nominal euro terms, the states with by far the biggest exposure are Germany (92B), France (70.3B), Italy (61.5B) and Spain (42.3B).

If Greece leaves the EZ and the Greek government defaults on its debt, how will the political leaders of the remaining EZ members explain the resultant hit to their taxpayers? If they were honest (which, of course, they aren’t), the explanation would be along the lines of:

“On my watch we transferred an amount of money equivalent to more than 3% of our country’s GDP from you, the taxpayer, to various programs designed to bail out your counterparts in Greece. Actually, that’s not true. Far from being bailed out by the money transferred from your good-selves, the Greek government was saddled with a vastly greater debt burden and Greece’s economy was pummeled further into the ground. It was actually the private holders of Greek government bonds who were bailed out. Why? Well, in my defense, Greece’s economy was in the toilet anyway and I was advised that there would be a euro-zone-wide financial crisis if the bond-holders weren’t bailed out. I’m aware that the current crisis is much worse than the crisis we avoided by implementing the bailout, but there’s no point crying over spilt milk. So, please let bygones be bygones and vote for me anyway.”

The desire to avoid having to make a sanitised version of the above speech will be a powerful motivator as Greece-related deadlines approach over the weeks immediately ahead.