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Currency hedging is a prudent strategy

Friday 4th May 2001

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Limiting risk of loss from exchange rate fluctuations is, or should be, the reason for industrial companies, financial institutions and individuals to take currency hedges.

While several New Zealand companies and large trading organisations, such as the Dairy Board, have said they gained or lost on hedging it is hard to find many that play the currency speculation game as an adjunct to their basic businesses.

Hedging the New Zealand dollar is a standard and prudent strategy for any organisation involved in international markets, whether as a financial investment fund or an industrial/commercial company.

It is no fault of companies, using expert advice from currency specialists, that some were on the wrong side of the ledger over the past year.

It is only with hindsight anyone could have anticipated the sudden and rapid decline of the New Zealand dollar against the US currency over the past year.

While media reports of company meetings emphasise the dissatisfaction of a few shareholders who specialise in criticism of boards and executives, particularly when they get currency hedging "wrong," there is limited, or no, recognition of the problems of currency management.

Just as there is also usually no recognition of situations where companies and trading organisations got it "right."

A peculiar situation arises when a company is involved in commodities sold in prices based on another currency. Goldminers are a specific example in the New Zealand context.

Otter Gold Mines was in the gun last year when shareholder Guinness Peat Group was critical of its hedging performance. The company's last interim report explained the intricate situation: "The mark to market [close out value] of gold and silver contracts (including Otter's equity interest in Allstate) was negative $NZ15.0 million ($A11.9 million) as at December 30, 2000, an improvement on the position at June 30, 2000 (negative $NZ27.0 million ($A20.8 million).

"The close out value fluctuates with changes in the spot gold price, gold lease rates, interest rates and exchange rates.

This potential gain or loss is only significant if the company was to close out its hedging arrangements at that time. Otter and Allstate enter their hedge contracts to guarantee future minimum delivery prices, not to speculate on market conditions."

It is a view most hedging companies would endorse and it encapsulates the issues involved in getting it "right" or "wrong."

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