For many companies, high prices for precious metals and their volatility present a significant dilemma, which at times has serious consequences for internal profit and loss calculation. For this reason, more and more precious metal users are actively turning to the existing market tools for hedging price risks. To do this, procurement and treasury departments usually work closely together. The latter becomes particularly involved when a company also uses complex financial products.
In general, companies have the following choices for hedging prices.
Cash transactions
In a cash transaction, precious metals are bought or sold at the current daily price. Payment obligations are executed two days after concluding the deal. In a cash transaction, as in all commercial transactions, agreement is reached on a location of the physical delivery. If a book transfer is involved, the purchaser will give the address of the account at which a credit is available for transfer to a precious metal account.
In international precious metals trading, metals are usually traded in dollars per fine ounce.. Contracts can be executed either in US dollars or in Euros.
Metals Swaps and Delivery
Two forms of swaps that occur only in the precious metal business include trading metals located at different storage sites (location swap) and trading metals with various grades of purity (quality swap). In this case, the prices for the swap are based on the costs of transportation and/or insurance, or of reprocessing to achieve a different level of quality.
Forwards
Forwards involve the purchase or sale of precious metals against a defined currency at a defined point in time at least three working days in the future. In the interbank market, such deals are often concluded for a standard period of one to 24 months, though a market also exists for forwards that lie between these standard periods. Longer periods do exist but these are typically hedging deals between mining companies and banks. The rate at which a forward is calculated is based on the cash rate and the basis of the difference between the interest rates for the metal and for the currency.
Futures - a special form of forwards
Futures are contracts that are standardized sizes, delivery points, delivery dates and grade of metal. The calculations are based on the same as those used to calculate forwards which are traded on an organized market. The most important markets for precious metals are the TOCOM in Tokyo, the NYMEX/COMEX in New York and the CBOT in Chicago. In these markets there are deposit requirements called margins, margin calls and other account maintenance which may be cumbersome for smaller industrial customers.
Limit orders
If a customer plans a precious metal purchase or sale, and would like to execute the transaction at a certain price limit at anytime while the market is open then Heraeus offers them the ability to leave us a Limit Order.
In this instance the customer leaves an order with Heraeus to be automatically executed in the market when a specified price limit is reached. Thanks to the global networking of Heraeus precious metals trading, around the clock monitoring of limit orders is assured. After completion of an order, it can be handled either as a cash transaction (payment of metal and the value after two days) or can serve as the basis for a forward deal.
Options
In addition to cash transactions and forward deals, options are the next most popularly used financial product in the precious metal industry. An Option is a contract that gives the buyer either the right to buy or sell at a specified price for a specified delivery period. For that right the buyer pays a cost or premium. The buyer has no obligation to execute the transaction.This a useful tool that serves as an insurance plan to protect against price risk when the market is volatile.
Options are available on the commodities exchange markets as well as Over the Counter. Heraeus offers Options for gold, silver, platinum, and palladium, but not for rhodium, ruthenium, and iridium. The minimum amounts in a single deal are 500 ounces (about 15.5 kilo), or 3 x 250 ounces in a series of consecutive monthly due dates. Options are generally due two days before the last working day of a month (exercise date); other dates are possible at any time. A physical delivery can be agreed on.
Various option strategies
- Zero cost option
This is the combination of the sale of an option and the purchase of an option (or the reverse). Both premiums are calculated together and as a result, in the ideal case the strategy entails no costs. The buyer is hedged against a rising price, and can participate to a limited extent even in falling prices.
- Option series
The purchaser of such a series buys such things as an entire sequence of options with the same basis prices, but with various consecutive due dates.
- Knock-in / Knock-out options
A few years ago variants of the so-called “exotic” options developed. A knock-out call option lapses when the cash price sinks below a price level agreed upon at the conclusion of the deal. The lapsing of the option at this time is however balanced by the fact that the purchaser can buy the metal more cheaply in the cash market, therefore the option, which had been conceived as insurance against rising prices, is thus no longer necessary. Because of the built-in possibility of such an option lapsing, the premium to be paid initially is lower than that for a standard option. Generally, the use of these options is limited to the interbank market or to deals with institutional investors.
