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How to go for hedging in gold

How to go for hedging in gold

Mon Apr 15 2019



What is hedging?


Taking two contrary positions on an underlier to protect yourself from price risk and volatility.


How does it happen in gold?


Say you’re a jeweller. You have an order to sell a quantity of jewellery to a customer by say end of May. You have to buy gold bars from a bank or a bullion dealer, make jewellery and sell it by May end. All okay. But assume gold prices fall by May-end from the current level. You make an inventory loss if you buy gold today. So, the moment you purchase gold from the spot market, you sell an equal quantity on a commodity derivatives exchange. Assume gold costs Rs 30,000 per 10 gm today. You buy a kilo of gold for Rs 30 lakh and simultaneously sell a futures contract for around the same sum. Now assume if by May-end gold falls to Rs 29,000. Had you not hedged yourself, you would face an inventory loss of Rs 1,000 per 10 gm, and the price of jewellery too would reduce.


Had you hedged, the loss of Rs 1,000 on spot would have been made up by a corresponding gain on the futures market (where you sold). When you actually sell jewellery worth a kilo, you would buy back what you sold on the futures market and be net neutral.


In practice hedging has a cost and only those companies with scale and experienced treasury hedge themselves.


Where do companies hedge gold?


Either on the over-the-counter market dominated by banks or on commodity exchanges like MCX. More recently, the BSE and NSE have launched gold derivatives. With time these would gain traction, stakeholders believe.


Who is the counter-party to the hedger?


The counter-party is the speculator — hedge fund or retail — who takes an informed decision contrary to that of the hedger.