May 8, 1997 in Nation/World

Hedging Pays Off For Pegasus Strategy Of Selling Gold In Advance Helps Offset Sluggish Metal Prices

Grayden Jones Staff writer
 

Production dropped. Costs rose. Prices slumped.

The events that hit Pegasus Gold Inc. during the past three months could have been a recipe for disaster.

But thanks to a hard-line approach to selling much of its gold in advance, the Spokane-based company turned a potential money loser into a break-even quarter.

While traders sold gold on New York’s Commodities Exchange for an average price of $352 per ounce during the quarter, Pegasus earned $460 an ounce for its bullion - a whopping $108 premium.

The profits occurred because the company a year ago bucked conventional wisdom and sold gold in advance when the industry thought prices were accelerating.

While most mining companies hedge some of their gold, few sell as much in advance as Pegasus. Sometimes hedging catches companies by surprise and they lose millions. But for eight consecutive years, it has been a non-operating gold mine for Pegasus.

“The difference is discipline,” said Chief Financial Officer Phillips Baker Jr. “Other companies, when they think prices are going up, waffle. But we don’t wake up in the morning and decide to sell gold.”

The hedging program netted $9 million in the first quarter of 1997 and boosted Pegasus’ bottom line in what could have been an embarrassing period. Pegasus reported a net loss of $15,000 despite low gold prices and higher operating costs.

Although its final results were shy of the $13,000 profit recorded in the first quarter of 1996, Pegasus did not have the benefit of $400-per-ounce gold or a $709,000 income tax benefit that helped it post a profit last year.

Should low gold prices continue through December, officials said they could earn an extra $33.5 million from Pegasus’ hedging program. That would be nearly twice the $18.9 million garnered from the program in 1996.

Despite the success of its hedging program, Baker said Pegasus could earn far more if gold prices shot up.

“Our objective is not to hedge, but to maintain as much unhedged gold as possible,” Baker said from Pegasus’ 15th floor headquarters in the Farm Credit Bank building. “Should gold go up, our shareholders would benefit.”

The spot price in New York for an ounce of gold Wednesday was $341.20, compared with $394.20 one year ago.

Baker, Pegasus Treasurer Michelle Viau and Chief Executive Officer Werner Nennecker are responsible for setting the company’s hedging policy. They receive no compensation for the success or failure of the program.

The trio stick to a scientific strategy for selling certain amounts of gold in advance at set prices regardless of the market climate and industry forecasts.

“It can be pretty lonely,” said Baker, noting that Pegasus was hedging its gold last year when prices were $418 per ounce. “We felt like we were the only ones selling.”

Pegasus spends about $250 to produce each ounce of gold, close to the industry average. Pegasus depends on its hedging program to help cover such anticipated costs.

Pegasus this year has sold 78 percent of its 570,000 ounces of gold production in advance to cover its cost to operate five mines, to pay off debts and to finance maintenance, administration and exploration costs. Most of Pegasus’ gold is sold to large investment banks that act as intermediaries to the jewelry industry and other end users.

Pegasus has earmarked 18 percent of its 6.5 million ounces of known reserves for advance sales. It has contracts for 720,000 ounces, averaging $441 per ounce, through 2003, and another 905,000 ounces, averaging $419 per ounce, of contingent sales from 1999 through 2003.

Since 1987, the company has generated nearly $89 million in additional revenue by hedging its gold. The annual average gain the past eight years was $11.7 million.

But hedging doesn’t always pay. In 1987-88, when gold briefly topped $500 an ounce and averaged more than $400, Pegasus lost $4.4 million on its hedging program.

“That’s why we don’t get bonuses for hedging,” Baker said.

, DataTimes ILLUSTRATION: Graphic: Hedging its bets


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