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It is July 2020. A mining company has just discovered a small deposit of gold. It...

It is July 2020. A mining company has just discovered a small deposit of gold. It will take six months to construct the mine. The gold will then be extracted on a more or less continuous basis for one year. Futures contracts on gold are available with delivery months every two months from August 2020 to December 2020. Each contract is for the delivery of 100 ounces. Discuss how the mining company might use futures markets for hedging.

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Answer #1

Here the mining company can use the futures market for the purpose of hedging in a systematic and structured manner. The first thing that it needs to do is to estimate its monthly production figures. Once this is done then the mining company can short futures contracts to lock in the price received for the gold.

Suppose that the mining company estimates that its production will be 5,000 ounces in the month of October 2020. In this case the mining company will be able to hedge the price received for its production by shorting a total of 5,000/100 = 50 October 2020 contracts.

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