Can Companies Use Hedging Programs to Profit from the Market? Evidence from Gold Producers

14 Pages Posted: 18 Dec 2008

See all articles by Tim Adam

Tim Adam

Humboldt University

Chitru S. Fernando

University of Oklahoma - Michael F. Price College of Business

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Abstract

In this article, the authors summarize the findings of their recent study of the hedging activities of 92 North American gold mining companies during the period 1989-1999. The aim of the study was to answer two questions: (1) Did such hedging activities increase corporate cash flows? (2) And if yes, were such increases the result of managements ability to anticipate price movements when adjusting their hedge ratios? Although the author's answer to the first question is yes, their answer to the second is no.

More specifically, the authors concluded that:

- During the 1989-1999 period, the gold derivatives market was characterized by a persistent positive risk premium - that is, a positive spread between the forward price and the realized future spot price - that caused short forward positions to generate positive cash flows. The gold mining companies that hedged their future gold production realized an average total cash flow gain of $11 million, or $24 per ounce of gold hedged, per year, as compared to average annual net income of only $3.5 million. Because of the positive risk premium, short derivatives positions did not generate significant losses even during those subperiods of the study when the gold price increased.

- There was considerable volatility in corporate hedge ratios during the period of the study, which is consistent with managers incorporating market views into their hedging programs and attempting to time the market by hedging selectively. But after attempting to distinguish between derivatives activities designed to hedge and those designed to profit from a view, the authors conclude that corporate efforts to time the market through selective hedging were largely if not completely futile. In fact, the companies' adjustments of hedge ratios appeared to consistently lag instead of leading the market.

Suggested Citation

Adam, Tim and Fernando, Chitru S., Can Companies Use Hedging Programs to Profit from the Market? Evidence from Gold Producers. Journal of Applied Corporate Finance, Vol. 20, No. 4, pp. 86-97, Fall 2008. Available at SSRN: https://ssrn.com/abstract=1317106 or http://dx.doi.org/10.1111/j.1745-6622.2008.00206.x

Tim Adam (Contact Author)

Humboldt University ( email )

Dorotheentr. 1
Berlin, Berlin 10099
Germany
+49 (0)30 2093-5641 (Phone)
+49 (0)30 2093-5643 (Fax)

Chitru S. Fernando

University of Oklahoma - Michael F. Price College of Business ( email )

Adams Hall
307 West Brooks Street
Norman, OK 73019-4004
United States
405-325-2906 (Phone)
405-325-7688 (Fax)

HOME PAGE: http://faculty-staff.ou.edu/F/Chitru.Fernando-1/

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