IMF draft report expects more depreciation of U.S. dollar


By Alden Bentley

NEW YORK, Aug. 26 (Reuters) -- The once frothy gold
options market is drying up as mining companies
comply with new hedge accounting rules and try to
retain the confidence of investors still infuriated by the
gold derivatives debacle four years ago.

As part of an industry trend to reduce the size of hedge
books and get more benefit from a rising market price
of gold, big producers have scaled way back on
structured hedging programs involving the purchase
and sale of call and put options to protect the value
of in-ground gold reserves.

One result is that over-the-counter gold options have
grown prohibitively expensive this year and implied
volatility -- a statistical measure of expected actual
price volatility used to value options -- has been

Producer hedging was the backbone of a
once-thriving gold options market. Now liquidity has
dried up and without this important source of revenues
and liquidity for their gold own trading, major bullion
banks are rethinking their franchise.

"You can't buy options any more because there is
no producer selling them the way they used to. So
some of this may be driven by the shape of dealers'
books," said a dealer at a precious metals trading firm.

"I mean, you can buy them, but but you have to pay
up," he said, referring to options on futures that are
freely traded contracts on the COMEX division of the
New York Mercantile Exchange.

Many mining companies were enamored with
options when the price of gold was falling to 20-year
lows in August 1999. By using options and forward
sales they generated revenues even when the
cash cost of digging and processing gold was
higher than the market price of bullion, which neared
$250 an ounce

Just as investors were breathing easier after the
Long-Term Capital Management hedge fund liquidity
scare of 1998, gold had its own derivatives fiasco
when prices suddenly started to recover in September
1999. Bullion toyed with $390 this year.

The short-covering spike nearly wiped out two
mid-tier mining companies, Ghana's Ashanti Goldfields
and Canada's Cambior, which had oversold and were
unable to come up with either physical gold to cover
their positions, or hundreds of millions of dollars to top
up collateral with their bankers.

These margin call were renegotiated, narrowly averting
what could have been a market-wrecking run on gold.

"A lot of trading houses and banks since that time have
tried everything to avoid situations like that," said the
head of mine finance at a commercial bank. "As a result,
companies who are in good credit standing have been
able to get unmargined lines so that they can't get into
that situation."

In January 2001, U.S. Financial Accounting Standard
Rule 133 required more transparency on hedging, by
tightening up the definition of a "derivative," and
requiring all derivatives to be recorded on a company's
balance sheet at fair market value.

"The titanic turn really was the whole Ashanti-type
thing (when) the possible weakness of the hedge
books were exposed and shareholders became
substantially more aware," said Jessica Cross,
CEO of gold research firm Virtual Metals Inc.

More producers are taking advantage of the gold
sector boom to use equity financing to develop
projects. Bankers can no longer arm-twist big
mining companies with good credit ratings to buy
price protection programs as a term of borrowing.

So the number of banks who offer mining project
finance as a core business continue to shrink.

"The bullion banks seem to be a bit on the back
foot now," said Cross. "The producers are saying
we actually aren't going with that. Take or leave it.
We're not going to hedge. You are not going to
dictate to us what our hedging terms are."

A typical strategy involved buying puts, which
give the mining company a floor price by
conferring the right to sell its gold at a preset rate.
A producer could finance all or part of this cash
outlay by selling calls, obligating it to sell gold if
the price rises thereby forfeiting some upside

But in a sellers market, speculative demand for
gold and gold calls has fanned real volatility and
helped peg implied "vols" near 20 percent for
several months. Around 12 percent used to be
normal before gold started rallying this year.

"Don't forget that there are new longs out there
who, to extent they are sophisticated enough,
now have the same positions as miners," said
a gold banker. "To the extent they want to sell
options against their holdings, they can. So you
may see other people stepping in. But certainly
not in the concentrated way that producers had


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Centennial Precious Metals
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Phoenix, Arizona 85032
Dr. Fred I. Goldstein, Senior Broker



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