Barrick Gold Corporation lifts hedge, gold hits $1200

Gold hit $1200 an ounce as Barrick Gold Corporation, a mining company, has lifted its short “hedge” in its entirety. As one who has held the NFA Series 3 license, which I voluntarily withdrew so that I could return to trading futures personally, I detected huge problems with prevailing hedging theory. I did very well on my Series 3 exam (obtained my Series 3 license) because I knew what the answers are supposed to be, but the prevailing theory on futures hedging is wrong.

Pursuant to prevailing hedging theory, one is to take a position in the futures market that is opposite to the cash (i.e., spot) market. Thus if somebody is long 100 ounces of gold in the cash market (i.e., owns 100 physical ounces of gold), then one would take a short position in the futures market. This is considered to be a short “hedge.” The argument in favor of such a short “hedge” is that losses in the futures market will be offset by gains in the cash (i.e., spot) market.

There is one big problem with this analysis. This analysis takes for granted that somebody even has an inventory to begin with. Furthermore, if your losses in the futures market are being offset by gains in the cash market, this is a different way of stating that gains in your cash market position are being offset by losses in your futures position. In an inflationary paradigm, firms will have a difficult time replacing inventory if they are merely breaking even in nominal terms.

As I thought this through carefully, I realized that the futures industry abuses the word hedge. As one can see in an inflationary scenario with a short “hedge,” the true hedge is not the futures position, but the inventory.

As one who has held the Series 3 license, it is my humble opinion that the futures market should be looked at as less of a hedging vehicle than merely an efficient way to buy and sell without having to make or take delivery. The real hedge in the gold/silver futures market is the physical inventory. Of course, nothing moves up or down in a straight line. Rather than sticking with a short “hedge,” bullion producers just may want to take time to exercise more discretion when plotting entry and exit points – viz., buy low and sell high. The dollar is on its way down thanks to central bank policy, and Barrick Gold did good to lift its short “hedge.”

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