The fifth day of Christmas – sourcing /hedging strategies for precious metals

We have looked at our procurement strategy with respect to our annual purchase of five gold rings and the summary findings are given here.

The gold market is one of the most volatile of the commodity markets, but unlike edible commodities it is not driven by weather patterns, crop failures, etc. Rather it is heavily influenced by world economic events and the prospects for other asset classes – stocks and shares, bonds, property etc. Most significantly, gold is seen as a hedge against loss of value in paper (fiat) currencies, so the prospects for inflation strongly affect the gold price.

As a globally traded commodity, we also have various options in terms of hedging our future purchases. If we want to lock in prices for our annual requirement (or for longer), we can purchase gold futures – the option to buy in the future at an agreed price. (As gold is traded in dollars, that would bring issues of currency risk as well of course). We could also look at proxies for actual physical gold – buying shares in gold mining firms for instance, whose shares tend to rise when he gold price rises.

However, if we feel we can beat the markets by clever trading, we should probably give up our core business and become full time gold traders!  Given that, I suggest two simple alternative strategies:

1. Lock in our annual requirement through forward buying at the beginning of the year so at least for budgetary purposes we know where we are.

2. Buy at regular intervals through the year – so buy one gold ring every ten weeks – which  is likely to mean we buy at something close to market prices over the year.

In terms of risk, the first option carries the risk that we buy badly against the market; but takes away our planning / budget risk. The second option means we take the risk of market movement, and of budgeting uncertainty – but we should buy at around market price.

Unfortunately, there is no risk free option....!

Peter

 

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