It is well known that it takes several years to extract all the gold from the mine. When a gold mining company decides to start production at a particular mine, it has a big aspect to the price of gold. If the price of gold decreases drastically, a mine might become unprofitable. Of course, every gold mining company should consider hedging against changes in the price of gold. However, it is very important for mining companies to communicate their hedging strategies to shareholders. Some gold mining companies choose not to hedge and try to attract shareholders who buy gold stocks. Such shareholders want to benefit when the price of gold increases and are ready to accept the risk of a loss from a decrease in the price of gold. However most of gold mining companies choose to hedge. The alternative investment management strategy is to estimate how much gold they will produce each month for the next few years and enter into short futures or forward contracts to lock in the price for all or just a part of this. Certainly, it will increase risk for the treasurer if other parties at the firm do not understand the role of hedging. Hedging strategy must be fully understood and communicated between firm’s managers, board of directors and shareholders.
Imagine you are a alternative investment management company, which is reached by a gold mining company which wants to sell you a fixed amount of gold in 1 year at a fixed price. What procedure you should follow? The solution is that you can borrow gold from central bank, then sell it in the spot market, and invest the inflow at the risk – free rate. After one year, you should buy the gold from the gold mining company and use it to repay the bank.