Price Volatility and Hedging Solutions in Gold Prepared for: 2012 India International Gold Convention August 25, 2012 Bimal Das Director, ScotiaMocatta and Marketing Manager, the Americas
ScotiaMocatta – A Premier Bullion Bank ScotiaMocatta, the precious and base metal division of The Bank of Nova Scotia, is a global leader in metals trading, finance and distribution of physical precious metal. Since 1671 the Mocatta® name has been synonymous with excellence. Over Three Centuries of Precious Metals experience backed by the security of Canada’s most international bank Deal execution across 5 continents 24 hour market capabilities Extensive coverage both in terms of product range and geographic location Local expertise with a global reach Founding and current member of the Gold and Silver Fixings Member of the COMEX division of the CME Authorized metals depository for most US exchanges Over 160 market professionals dedicated to ScotiaMocatta business
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ScotiaMocatta – A Premier Bullion Bank Our fully integrated and comprehensive range of metals services include:
Global Market-Maker
Precious Metals financing
Global Physical Delivery
Fixing Services
Scrap Purchase programs
Hedging Programs
Vaulting and Custodial Services
Coins / Investment Bars
Structured Financing
Forward Rate Agreements/IRS
Metal Certificate Programs
Reserve Management
Metal consignments and leases
ETF Conversions
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ScotiaMocatta – Global Locations
Toronto
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The Big Picture The Western World is struggling with the debt many countries have allowed to build •
Existing debt may have to be written off – resulting in defaults
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More layers of debt may have to be created, exacerbating the risks of hyper-inflation
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Tough economic decisions for the foreseeable future, especially in Europe and the US
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Falling confidence in the global economy and Governments’ ability to spur growth
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QE programs have stimulated growth, but at the cost of commodity inflation
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Central Banks have fewer tools left to fight inflation given low GDPs
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Deeper slowdown in Indian and Chinese economies may spur safe-haven investments
However, positive signs are beginning to emerge •
Unemployment rates in the US are gradually improving
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Investor interest in equity markets are sharply higher
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Positive earnings in many industrial sectors
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QE3 is on hold for now
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Precious Metals Market Outlook Reasons for continued high price environment: •
Bullish sentiment prevails in market
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Strong Central Bank buying
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Geopolitical instability
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Inflation (in the US, the global economy or in commodity prices)
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Safe haven or alternate investment product
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ETF holdings in gold are at an all time high at 78 MM ounces
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Mining shareholders’ desire to be exposed to rising prices
Reasons for a sell-off: •
Liquidation of large speculative long positions
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Prolonged economic weakness - soft demand
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Increase in US dollar interest rates
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Gold Snapshot – Last 10 Years vs. 1980s
2003
2004
2005
2006
2007
2008
[courtesy Bloomberg]
2009
2010
2011
2012
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Spot Gold: 2012
[courtesy Bloomberg]
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Spot Gold Prices
[courtesy Bloomberg]
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ETF Holdings vs. Spot Gold
[courtesy Bloomberg]
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ScotiaMocatta Research
[courtesy www.ScotiaMocatta.com]
After the strong gains seen between 2008 and 2011, it is not surprising that the market has taken a long time to consolidate Europe’s financial system is straining at the seams and with no fix forthcoming, demand for safe-havens is likely to remain strong Precious metals prices are generally consolidating. But with good underlying support evident, there may be opportunities for rallies Resistance in gold has proved difficult to clear with technicals indicating consolidation may be required. Although prices have been range-bound recently, on balance we expect the price consolidation to lead to another rally before too long A series of higher lows since mid-May suggests that there is good underlying buying interest. There appears to be pressure building up beneath resistance and we should not be surprised to see prices attempt a move above $1641 Fund and investor interest has re-emerged. With other safe-havens looking expensive, bullion looks relatively cheap Net long fund position (126k contracts) has started to recover from recent lows Large funds and investors like Paulson & Co. and Soros Fund Management have recently re-entered the market Gold ETF holdings are at an all time high – 78.22 million ounces www.ScotiaMocatta.com 10
Hedging Tools and Alternatives Metal Loan / Lease Facility Fixed Price Hedges • Spot • Forward Contracts and Flat Forward Prices • Futures Exchanges Variable Price Transactions • Options
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Precious Metal Loans / Leases Advantages • Creates a natural price hedge for inventory against price volatility • Loan programs can incorporate the process of acquiring metal • Precious metal borrowings do not tie up expensive capital • Borrowing costs are historically lower than traditional financing • Allows borrower to maintain equity gold position through LIFO accounting Disadvantages • Rising metal prices may increase interest costs • Metal borrowing rates can be volatile • Borrower does not participate in rising prices • Rising metal prices may increase credit collateral costs
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Forwards, Futures Contracts & Options
A forward contract is a non-standardized contract between two parties to buy or sell an asset at a specified future date at a price and location agreed upon today A futures contract is a standardized contract between two parties to buy or sell a specified asset of standardized quantity and quality for a price agreed today with delivery and payment occurring at a specified future date. Futures contracts are typically traded on an Exchange (Comes, MCX, TOCOM etc.) An option contract gives the option buyer the right (but not the obligation) to buy (a Call option) or sell (a Put option) a specific underlying asset (commodities, currency, stocks, indices, debt etc.) at an agreed price (the strike price) during a pre-determined period of time. The obligation (not the right) rests with the seller
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Forward Contracts Identify when the Price Risk arises and understand what the risks are Quantify the Risk. How Long does the Risk Exist? Determine Hedge Objectives and Impact of Hedge on Business Positives • Complete protection against price volatility in the gold price • Allows consumers to lock in prices without using up cash resources • Ensures predictable pricing for manufacturing and costing Risks • No participation in directional market movements • Forward contract premiums could be expensive • Could potentially lock in gold at the all time high gold price
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Hedging – Forwards & Flat Forward Date
Forward Price *
Flat Forward Price *
1 Month
$1641.25
$1648.15
3 Months
$1642.75
$1648.15
6 Months
$1644.00
$1648.15
9 Months
$1652.25
$1648.15
1 Year
$1656.75
$1648.15
* Based on Spot Gold Price of $1640 * Prices and rates subject to market changes 15
Option Contracts Consumers can protect against rising prices by buying a CALL# option. But current atthe-money Call options could cost up to $60 per ounce in option premiums An alternative could be to sell a PUT+ option
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Creates an obligation for the options seller to BUY GOLD
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Seller typically receives a premium from the Buyer
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The Seller receives a payment (premium) to leave an order below current market prices in exchange for assuming an obligation to buy the underlying metal if the option is exercised*
For Example: (Assume Gold Spot Price $1640) •
Sell a three month PUT with a Strike Price of $1600
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Seller receives a premium of ~$25 per ounce
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If price trades below $1600 in three months, option is exercised
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Seller buys gold @ $1575 (Strike Price – Option Premium)
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If price trades above $1600 in three months, option expires un-exercised and Seller keeps the $25 / per ounce premium received
# A Gold CALL option gives the buyer of the option the right to BUY gold at the Strike Price if the market trades above the Strike Price on expiry of the contract + A Gold PUT option gives the buyer of the option the right to Sell gold at the Strike Price if the market trades below the Strike Price on expiry of the contract * Conditions may apply subject to terms of the option contract and the contract being exercised etc.
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