In a previous article I was baffled to see Pan American Silver (NASDAQ:PAAS) hedge approximately 25% of its expected annual production at fire-sale prices. The company hedged 5.3 million ounces of silver at a fixed price of $20.43/oz and 24,000 ounces of gold at $1,323/oz. As those hedging prices were quite low and the hedged amount of ounces relatively high, I thought this was a panic move by the Pan American management team.
Repurchasing the hedge
When Pan American Silver yesterday announced it would accelerate the deliveries under the hedging agreement and repurchase a part of the hedge, I was surprised again by this sudden change of mind.
According to the press release, PAAS announced that 'Through accelerated physical metal delivery and straight repurchase, Pan American now intends to close all of these forward contracts before the end of the current year.' According to CEO Burns, PAAS chose to eliminate these hedges now, because 'our action may have inadvertently sent the wrong message to the market and to our shareholders about our hedging philosophy and our view of the long term prospects for silver and gold'.
So just two months after hedging a large part of its output, the company regrets this hedge and is now aiming to remove it by the end of this year.
So how much will the total damage be?
Let's assume now the company will deliver 3.2M ounces of silver and the entire 24,000 ounces of gold under the hedging program, leaving a hedge on 2 million ounces of silver to be repurchased. Using the average hedge price of $20.43/oz of silver and today's silver price of $23.13, repurchasing this hedge would cost the company $5.4M.
I might be ranting a bit here, but I consider $5.4M to be a steep price to rewind something which was only be decided two months ago and I think the PAAS has better options to spend this money on, as $5.4M would have allowed them to pay an additional $0.033 dividend per share or to buy back an additional 500,000 shares for cancellation.
Whilst I'm happy the company realizes a lot of shareholders were extremely surprised by the move to hedge a substantial part of its output at a low price, its 'mistake' will very likely cost the company $5M (not including realized losses on ounces delivered under the hedging program). I still have the impression the management team was panicking back in July and the fact PAAS team is now scrambling to undo the damage doesn't exactly fill me with confidence about the leadership capabilities in the board room.
I still have a long position in PAAS and will increase my position, but I hope Burns et alii can keep their nerves under control next time and prove to be experienced skippers during this volatile environment.
Disclosure: I am long PAAS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.