The CEO of gold mining company DRD, Niël Pretorius, made the following commitment when reporting good recent results: “For the foreseeable future the company will stick firmly to its preference for funding growth without leaning on debt. DRDGold has also promised not to lock in elevated gold prices through hedging. The one undertaking that I do give is that for as long as we can, we will remain unhedged, and we will give you full exposure to movements in the gold price.”
Shareholders in DRD no doubt approve of their exposure to the gold price. They typically hold shares in gold mining companies as a small part of diversified portfolios. They are well hedged generally and appreciate the extra upside gold shares can offer to the gold price — as DRD has succeeded in providing.
Since 2015 the value of a DRD share has increased nearly nine times faster than the gold price itself, providing more gearing to the moves in the gold price for DRD shareholders than any of the other gold miners listed on the JSE.
The recent ratio of the DRD share price to the price of gold in rand was 8.73 times (2015=1). Since August 2015 this gearing ratio for Harmony was 6.99, 6.18 times for Pan African, 4.96 for Gold Fields, 4.45 for AngloGold and 1.49 for Sibanye.
The annual average increase in the rand gold price since 2015 has been an impressive 17.6%. There are peaks and troughs in this cycle, though the gold price itself has been on an almost continuous long tear higher since 2000; the annual average increase in the rand price of gold has been 16.9% since 2000, with few and limited declines.
Why do gold mines ever hedge gold price risks? The answer is surely because the senior professional managers of any business are mostly far less diversified than their shareholders. The present value of their expected benefits from continued employment will likely far exceed the value of any company shares they may own.
Hence their observed reluctance to retain shares awarded to them as a part of their packages. They may be encouraged to join the ranks of shareholders so they will act like them, but they prefer not to do so because they have a concentrated interest in the companies they work for. Accordingly, they are likely to be more risk averse than the average shareholder and so more likely to hedge to help secure their futures.
This is why knowledge of the “skin in the game” of directors, the value of their shares, may indicate the direction hedging activities will go. There is one sure lesson in hedging strategy, though: keep your shareholders well informed, as DRD has done, so that shareholders can knowingly choose to share in the risks or not.
Every company will have its own risks to cope with or take advantage of. For example, should South African-domiciled businesses hedge their exposure to specific local risks, knowing that their South African shareholders have full opportunity to hedge by holding a diversified portfolio of shares with foreign jurisdictions?
Their foreign shareholders will also be well diversified, and they expose themselves to South African risks for the potential upside. Foreign investing in South Africa is not typically a safety-first decision. As with the miners, the interests of shareholders and managers may not be fully reconciled.
South African managers may also have better reasons for investing shareholders’ capital offshore than their shareholders. The value of such direct investments inward and outward has grown strongly over recent years, from limited beginnings. Direct investments by South African businesses have grown to a value of over R3-trillion in 2024, first exceeding inward direct investment of about R2-trillion in 2013.
Direct investment is defined as being made by a controlling foreign investor, one owning more than 10% of the shares in issue. Clearly not all these investments by South African companies abroad have succeeded for shareholders. There have been many conspicuous failures, yet also several successes, including recent investments abroad made by originally South African mining companies.
Perhaps the lessons are best demonstrated by the performance of foreign direct investors in South Africa. They invest here for its expected return on capital, doing so for the same reasons they invest globally. It is not to diversify exposure to their domestic economies but to profitably scale up the application of their intellectual property in the South African market.
When investing abroad, South African businesses should not be doing so to diversify risk. Shareholders are perfectly capable of doing that for themselves. The understandable interest managers will have in diversifying their South African employment risks should not be the compelling purpose.
The confidence of the managers in their ability to scale up their own intellectual property should be the primary motivation — a goal not easily satisfied, it should be stressed. Investment decisions should rely on business properties powerful enough to enable them to compete successfully with well-established and capable and well-capitalised domestic operators.
Without this essential capability, the case for investing abroad will be weak — a case that potential and actual shareholders will recognise and resist, valuing their shares accordingly.
• Kantor is head of the research institute at Investec Wealth & Investment. He writes in his personal capacity.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.