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Legacy Hedge

Legacy Hedge
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What Is a Legacy Hedge?

A legacy hedge is a long-term hedge position, frequently a futures contract, that a company has held for an extended period of time. Commodity companies frequently hold legacy hedges on their reserves to safeguard against adverse developments in the price of the commodities that they produce or consume.

A legacy hedge will frequently be put in place by an entity that expects the type of risk covered by the hedge to be pretty much relentless or applicable as long as necessary.

Understanding Legacy Hedges

A legacy hedge is a way for a commodity company to guarantee a return on the sale of a commodity far into what's in store. A few commodities, like oil or precious metals, experience continuous shifts in market price.

To balance out their revenue streams, they might hedge against price volatility by signing a futures contract, an agreement to sell a commodity on a predetermined date at a predefined price. They successfully lock in the spot price of the commodity at the time they sign the contract.

For the amount of the commodity in the legacy hedge, the company has given up any likely gains from a price increase in exchange for protection against expected losses from a price drop.

While the commodity company would invite the extra profits from rising prices, guaranteed compensation might be more significant as it permits the company to go with management choices in light of a stable future income stream.

Upsides and downsides of Legacy Hedges

Any hedge position can cut the two different ways. If the spot price has increased when the futures contract terminates, the company will wind up selling the commodity below the current market value. In the event that the spot price has diminished, the company will sell above market value.

As a long-held hedge position, a legacy hedge can have a particularly emotional stabilizing, especially in the event that a fundamental shift in market powers influencing the commodity happens meanwhile.

For instance, any gold producer who marked a 10-year futures contract in 2001, locked in the spot price when gold was trading at under $300 per troy ounce. Before the contract expired, the US housing market crashed and the global economy experienced the Great Recession.

The price of gold soar as the stock market fell and faith in the US dollar wavered universally. In 2011, when the contract would have expired, gold prices moved as high as $1,889.70 per troy ounce. Any gold tied up in the futures contract didn't deliver to the gold producer the benefit of the over 500% increase in price over the 10-year period.

While gold prices have since gone all over, at more than $1,724 per troy ounce as of March 12, 2021, they remain essentially higher than pre-Great Recession prices, so any gold producer actually sitting on legacy hedges laid out before gold prices shifted vertical is perched on losses.

Highlights

  • A legacy hedge is a hedge that has existed for quite a while and is expected to continue into what's to come.
  • Legacy hedges are involved by commodity-related companies to guarantee a price for a product that they hope to purchase or sell for the life of its operations.
  • A legacy hedge commonly won't be taken off except if something fundamental changes or disaster will be imminent in the event that the entity holding the hedge position leaves business.