Saturday, May 15, 2010

Freeport-McMoRan (NYSE:FCX), Southern Copper (NYSE:SCCO), Yamana Gold (NYSE:AUY) Could All be Hurt by Derivative Reform

The rush by lawmakers in the U.S. to throw out some new regulations could backfire as usual, as the move to regulate derivative could harm companies like Freeport-McMoRan (NYSE:FCX), Southern Copper (NYSE:SCCO), Yamana Gold (NYSE:AUY), who use them for hedging and financial management.

Talking about derivatives in any way get be confusing and complicated, so we'll just keep it to the obvious basics, and that is hedge their risks in areas like currency fluctuations, energy costs, inceasing interest rates and the cost of output in the future, among other things.

A derivative is an instrument which derives its value from something other than itself, like the interst rates mentions above, or how currencies interact with one another.

What companies do is use these derivatives as management tools to have some control over the costs of these types of financial challenges affecting their business results.

The bad reputations associated with derivatives isn't related to those which are used to hedge the risks of companies, but those used to speculate, in which case they can destroy gigantic companies, as they did with Bear Stearns and others.

What proposed legislation could end up doing is pushing the trading of derivatives to exchanges, which would effectively remove much of the value of the types used to hedge risks for companies, as they wouldn't be able customize their to their specific circumstances, but would be forced to use standard contracts, which would be much less valuable and ultimately, more costly.

Taking that way would take away much of the purpose of derivatives, and the extra cost would be for a far less useful product.

Interestingly for Yamana, some investors don't understand the difference between derivative types, and they punish the company for their derivative exposure as a consequence of that.

For the others like Freeport-McMoRan, Southern Copper and many others, the cost of doing business and the risk associated with it will increase as a result, and that cost is always passed on to the end-user: the customer.

There's a lot more to it than this, but again, the complexities are enormous, and you can go down all sorts of roads attempting to explain it all.

The bottom line is derivative regulations seems to be headed down an avenue where one size will fit all, and if it does, it's going to end up doing a lot more harm than good, especially for those companies using them properly and strategically.

It's something to keep in mind and add to our data when researching companies to accurately measure their operational costs and potential margins.

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