Gold Exposure And Hedging Strategies Of 4 Gold Stocks

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Includes: ABX, AEM, GG, NEM
by: Alberto Abaterusso

Summary

Differences in hedging strategies most likely play a role in how changes in the price of gold explain returns on Goldcorp, Barrick, Newmont and Agnico Eagles.

This article investigates whether in the past gold hedging strategies usage may have reduced the equity return variability of GG, ABX, NEM and AEM.

I have chosen 2 specific years for my analysis: 2007 (gold price increased with 31.59%) and 2013 (gold price decreased with 27.79%).

Beta estimates of these gold stocks that decided either to not hedge gold sales or to occasionally enter into derivative transactions or use contracts which were classified as non-hedge derivatives.

Differences in hedging strategies most likely play a role in how changes in the price of gold explain returns on GG, ABX, NEM. Newmont Mining does not hedge gold prices.

(Comment by germiller to my article "An Analysis Of The Exposure Of 3 Gold Stocks To Their Underlying Precious Metal Price Changes".)

This article investigates whether in the past gold hedging strategies usage may have reduced the equity return variability of four gold mining stocks: Goldcorp Inc. (NYSE:GG), Barrick Gold Corporation (NYSE:ABX), Newmont Mining Corporation (NYSE:NEM) and Agnico Eagles Mine Ltd (NYSE:AEM).

I have chosen 2 specific years for my analysis: year 2007 during the gold price bull market and year 2013 during the falling phase of gold prices. In 2007 gold price increased 31.59% (the highest during the July 20, 1999 till September 5, 2011 period) and in 2013 gold price decreased 27.79% (the worst from October 2012 to December 2015). See table:

I analyze gold exposure for each firm (GG, ABX, NEM and AEM) to changes in gold prices which is estimated in the following market model; (Rit - rft) = alfa + betaM (Rmt - rft) + betaG (Rgt - rft) + errorit,, where Ri,t is the daily return on stock i, rft is daily return on the 3 month treasury bills, Rm,t is the daily return on the S&P 500 Index, and Rg,t is the total return on gold.

EXPOSURE OF GG, ABX, NEM AND AEM TO THE STOCK MARKET (S&P 500) AND TO THE PRICE OF GOLD IN 2007.

The price of gold during its bull market, from July 20, 1999 till September 5, 2011 (see the graphic above), ranged from $252.800 per troy ounce to $1895.000 per troy ounce. I chose the year in which the gold price had its higher uptrend, that is from December 29, 2006 - December 31, 2007. See table below:

The price of gold ranged from $635.700 per troy ounce on December 29, 2006 to $836.500 per troy ounce on December 31, 2007. The price of gold increased with 31.59% during 2007, the highest annual return on gold during its bull market.

From Barrick Annual Report 2007:

Rf, risk free rates, at daily frequency, are downloaded from the Dartmoth Library: The Tbill return is the simple daily rate that, over the number of trading days, in the month, compounds to 1-month TBill rate from Ibbotson and Associates Inc.

Data on GOLDAMGBD228NLBM, Gold Fixing Price 10:30 am (London time) in London Bullion Market, based in U.S. Dollars, U.S. Dollars per Troy Ounce, Daily, Not Seasonally Adjusted are downloaded from Federal Reserve St. Louis economic research website. I made sure that no data on the price of gold is missing, that each data on the price of gold is timely synchronized with the daily price of gold stocks, S&P 500 (Mkt), and then I can calculate return on gold price.

Daily prices of gold stocks and S&P 500 index (Mkt) are downloaded from Yahoo Finance.

The table below shows that the annualized means are: Gold return 29.47%; Stock Market return 4.29%; Risk Free rate (NYSE:RF) 4.54%. Gold delivered higher returns than the stock market, during 2007. Instead the difference between the two standard deviations (0.0098 vs 0.01) is not significant:

Now I will use a two factors model to calculate the gold beta: that is the relationship between the movements in the price of gold and movements in gold stocks.

E(Return on gold stock - Rf) = a + b1*E(Mkt - Rf) + b2*E(Return on Gold - Rf);

With all the data available I run the multiple regression function in Excel to have the summary report of my analysis for each gold mining stock (GG, ABX, NEM and AEM).

The following four pictures show summary reports of the gold mining stocks during the observed period, 252 observations (daily prices):

For Goldcorp Inc.:

For Barrick Gold Corporation:

For Newmont Mining Corporation:

For Agnico Eagle Mines Ltd:

Gold (and market) exposure for Goldcorp Inc., Barrick Gold Corporation and Newmont Mining Corporation is statistically significant during the December 29, 2006 - December 31, 2007 period.

Gold exposure for Agnico Eagle Mines Ltd is not statistically significant during the December 29, 2006 - December 31, 2007 period.

Table 1.

EXPOSURE OF GG, ABX, NEM AND AEM TO THE STOCK MARKET (S&P 500) AND TO THE PRICE OF GOLD DURING FALLING PHASE OF GOLD PRICE: YEAR 2013.

I chose the year, 2013 (see the graphic above), in which the gold price had its worse downtrend during its falling phase, from October 2012 to December 2015:

The same methodology I use to determine gold beta for the gold mining stocks.

The table below shows that the annualized means are: Gold return -31.51%; Stock Market return 24.01%; Risk Free rate , 3 month treasury bills: 0.00%.

The following four pictures show summary reports of the gold mining stocks during the observed period, 251 observations (daily prices):

For Goldcorp Inc.:

For Barrick Gold Corporation:

For Newmont Mining Corporation:

For Agnico Eagle Mines Ltd:

Gold (and market) exposure for Goldcorp Inc., Barrick Gold Corporation, Newmont Mining Corporation and Agnico Eagles Mine Ltd. are statistically significant during the January 3, 2013 - December 31, 2013 period.

Table 2.

Multiple R and R Squares are low but F (see summary output pictures for each gold stock above) is less than 0.05; this means that the set of independent variables used are ok and the results however are reliable and all P-values (for Rgg-Rf and Rkt-Rf) are below 0.05.

Finally I run a scatter plot of the residuals for each regression model. Each model is on average correct for all fitted values. The residuals seem to fall in a symmetrical pattern and have a constant spread throughout the range, see the pictures below:

Picture A):

Picture B):

Picture C):

Picture D):

Picture A) is residual scatter chart for Goldcorp Inc.;

Picture B) is the residual scatter chart for Barrick Gold Corporation;

Picture C) is the residual scatter chart for Newmont Mining Corporation;

Picture D) is the residual scatter chart for Agnico Eagles Mine Ltd.

CONCLUSION

The analysis performed over two years, 2007 (+31.59% raise in gold price compared to 2006) and 2013 (-27.79% tumble in gold price from 2012) shows that there is relatively not much difference in term of exposure of gold stock returns to changes in gold prices (see table 1 and 2). This may be explained because the gold mining stocks decided either to not hedge gold sales or to occasionally enter into derivative transactions or use contracts which were classified as non-hedge derivatives.

Goldcorp Inc. didn't hedge gold sales either in 2007 nor in 2013 (Goldcorp Inc. Annual Report 2013, page 67 and 140, and Annual Report, 2007, management's discussion & analysis, notes to consolidated financial statement).

Barrick used gold contracts which were classified as "non-hedge derivatives. The company used them in order to achieve its risk management objectives; however they did not meet the strict FAS 133 hedge effectiveness criteria. Their change in the fair value was recorded in earnings in a manner consistent with the derivative positions' intended use, but the non-applicability of hedge accounting could lead to significant volatility in corporate earnings (2007). And its 2013 financial statements say, all of its "future gold production was unhedged in order to provide its shareholders with full exposure to changes in the market gold price." (see Barrick Annual Report 2007 and 2013, notes to consolidated financial statements).

Newmont has historically entered into derivative contracts to protect the selling price for certain anticipated gold production and to manage risks associated with gold, but the company generally avoided gold hedging and its strategy was to provide shareholders with leverage to gold prices by selling its gold at spot market prices (see Note 14 to the Consolidated Financial Statements, Newmont Annual Report for 2007, and Newmont Annual Report 2013, note 17 derivative instruments).

In the past Agnico Eagles Mine Ltd. has occasionally entered into derivative transactions under its Metal Price Risk Management Policy, but at December 31, 2013, there were no metal derivative positions for the company (AEM Annual report 2007, note 15. financial instruments and Annual Report 2013, notes to consolidated financial statements - 15. financial instruments).

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.