Derivative Financial Instruments and Fair Value of Financial Instruments

3 Months Ended

Mar. 31, 2013

Derivative Instruments and Hedging Activities Disclosure [Abstract]

DERIVATIVE FINANCIAL INSTRUMENTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS

DERIVATIVE FINANCIAL INSTRUMENTS

Palmarejo Gold Production Royalty

On January 21, 2009, the Company entered into a gold production royalty transaction with Franco-Nevada Corporation. The royalty covers 50% of the life of mine production from the Palmarejo mine and adjacent properties. The royalty transaction included a minimum obligation of 4,167 ounces per month that ends when payments have been made on a total of 400,000 ounces of gold. As of March 31, 2013, a total of 184,851 ounces of gold remain outstanding under the minimum royalty obligation.

The price volatility associated with the minimum royalty obligation is considered an embedded derivative financial instrument under U.S. GAAP. As such, the Company is required to recognize the change in fair value of the remaining minimum obligation due to the changing gold prices. Unrealized gains are recognized in periods when the forward gold price has decreased from the previous period and unrealized losses are recognized in periods when the forward gold price increases. The fair value of the embedded derivative is reflected net of the Company's current credit adjusted risk free rate, which was 4.2% and 4.2% at March 31, 2013 and December 31, 2012, respectively. The fair value of the embedded derivative at March 31, 2013 and December 31, 2012, based on forward gold prices averaging approximately $1,609 and $1,694 per ounce, respectively, was a liability of $121.6 million and $145.1 million, respectively. During the three months ended March 31, 2013 and 2012, mark-to-market adjustments for this embedded derivative amounted to a gain of $23.5 million and a loss of $12.4 million, respectively.

Payments on the royalty obligation occur monthly resulting in a decrease to the carrying amount of the minimum obligation and the derivative liability and the recognition of realized gains or losses as a result of changing prices for gold. Each monthly payment is an amount equal to the greater of the minimum of 4,167 ounces of gold or 50% of the actual gold production per month multiplied by the excess of the monthly average market price of gold above $400 per ounce (which $400 floor is subject to a 1% annual inflation compounding adjustment beginning on January 21, 2013). For the three months ended March 31, 2013 and 2012, realized losses on settlement of the liabilities were $9.1 million and $13.2 million, respectively. The mark-to-market adjustments and realized losses are included in fair value adjustments, net in the consolidated statement of operations.

Forward Foreign Exchange Contracts

The Company periodically enters into forward foreign currency contracts to reduce the foreign exchange risk associated with forecasted Mexican peso (“MXN”) operating costs at its Palmarejo mine. At March 31, 2013, the Company had MXN foreign exchange contracts of $29.4 million in U.S. dollars. These contracts require the Company to exchange U.S. dollars for MXN at a weighted average exchange rate of 12.91 MXN to each U.S. dollar and the Company had an asset with a fair value of $0.8 million at March 31, 2013. At December 31, 2012, the Company had MXP foreign exchange contracts of $26.1 million in U.S. dollars. These contracts required the Company to exchange U.S. dollars for MXN at a weighted average exchange rate of 13.11 MXN to each U.S. dollar and the Company had a liability with a fair value of $0.1 million at December 31, 2012. The Company recorded mark-to-market gains on these contracts of $0.7 million and $2.7 million for the three months ended March 31, 2013 and 2012, respectively. These mark-to-market adjustments are reflected in fair value adjustments, net. The Company recorded a realized gain of $0.6 million and a realized loss of $0.8 million in production costs applicable to sales during the three months ended March 31, 2013 and 2012, respectively.

In connection with an arrangement agreement entered into with Orko Silver Corp., the Company entered into a forward foreign currency contract in the first quarter of 2013 to reduce the foreign exchange risk associated with forecasted Canadian dollars ("CAD"). Please see Note 20 - SUBSEQUENT EVENTS for additional information. At March 31, 2013, the Company had a CAD foreign exchange contract of $100 million in U.S. dollars. This contract requires the Company to exchange U.S. dollars for CAD at an exchange rate of 1.0 CAD to each U.S. dollar and the contract had a fair value of $98.4 million at March 31, 2013. The Company recorded a mark-to-market loss on this contract of $1.6 million for the three months ended March 31, 2013. This mark-to-market adjustment is reflected in fair value adjustments, net.

Concentrate Sales Contracts

The Company enters into concentrate sales contracts with third-party smelters. The contracts, in general, provide for a provisional payment based upon provisional assays and quoted metal prices. The provisionally priced sales contain an embedded derivative that is required to be separated from the host contract for accounting purposes. The host contract is the receivable from the sale of concentrates at the forward price at the time of sale. The embedded derivative, which is the final settlement price based on a future price, does not qualify for hedge accounting. These embedded derivatives are recorded as derivative assets (in Prepaid expenses and other) or derivative liabilities (in Accrued liabilities and other) on the balance sheet and are adjusted to fair value through earnings each period until the date of final settlement. At March 31, 2013, the Company had outstanding provisionally priced sales of $30.1 million, consisting of 0.1 million ounces of silver and 15,685 ounces of gold, which had a fair value of $29.6 million including the embedded derivative. At December 31, 2012, the Company had outstanding provisionally priced sales of $33.2 million consisting of 0.4 million ounces of silver and 11,957 ounces of gold, which had a fair value of approximately $34.1 million including the embedded derivative.

Commodity Derivatives

As of March 31, 2013, the Company had outstanding call options requiring it to deliver 92,000 ounces of gold at a weighted average strike price of $1,966.14 per ounce if the market price of gold exceeds the strike price. At March 31, 2013, the Company had outstanding put options allowing it to sell 109,500 ounces of gold at a weighted average strike price of $973.14 per ounce if the market price of gold were to fall below the strike price. The contracts expire by their terms over the next three years. At December 31, 2012, the Company had written outstanding call options requiring it to deliver 97,000 ounces of gold at a weighted average strike price of $1,967.89 per ounce if the market price of gold exceeds the strike price. At December 31, 2012, the Company had outstanding put options allowing it to sell 122,000 ounces of gold at a weighted average strike price of $967.86 per ounce if the market price of gold were to fall below the strike price. As of March 31, 2013 and December 31, 2012, the fair market value of these contracts was a net liability of $4.5 million and $9.3 million, respectively. During the three months ended March 31, 2013, 12,500 ounces of gold put options expired at a weighted average strike price of $921.60 per ounce, resulting in a realized loss of $0.5 million. During the three months ended March 31, 2013, 5,000 ounces of gold call options at a weighted average strike price of $2,000.00 expired. During the three months ended March 31, 2013 and 2012, the Company recorded unrealized gains of $4.8 million and $0.2 million, respectively, related to the outstanding options which was included in fair value adjustments, net.

As of March 31, 2013, the Company had the following derivative instruments that settle in each of the years indicated in the table (in thousands except average prices, ounces and notional data):

	2013		2014		2015		Thereafter
Palmarejo gold production royalty	$	21,297	$	24,895	$	24,691	$	20,766
Average gold price in excess of minimum contractual deduction	$	502	$	498	$	494	$	490
Notional ounces	42,433		50,004		50,004		42,409
Mexican peso forward purchase contracts	$	29,400	$	—	$	—	$	—
Average rate (MXP/$)	$	12.91	$	—	$	—	$	—
Mexican peso notional amount	379,422		—		—		—
Canadian dollar forward purchase contracts	$	100,000	$	—	$	—	$	—
Average rate (CAD/$)	$	1.00	$	—	$	—	$	—
Canadian dollar notional amount	100,000		—		—		—
Silver concentrate sales agreements	$	4,395	$	—	$	—	$	—
Average silver price	$	29.72	$	—	$	—	$	—
Notional ounces	147,898		—		—		—
Gold concentrates sales agreements	$	25,683	$	—	$	—	$	—
Average gold price	$	1,637	$	—	$	—	$	—
Notional ounces	15,685		—		—		—
Gold put options purchased	$	1,260	$	720	$	—	$	—
Average gold strike price	$	931	$	979	$	1,010	$	—
Notional ounces	32,500		47,000		30,000		—
Gold call options sold	$	—	$	720	$	—	$	—
Average gold strike price	$	2,000	$	1,934	$	2,000	$	—
Notional ounces	15,000		47,000		30,000		—

The following summarizes the classification of the fair value of the derivative instruments as of March 31, 2013 and December 31, 2012 (in thousands):

	March 31, 2013
	Prepaid expenses and other		Accrued liabilities and other		Other long- term liabilities		Current portion of royalty obligation		Non-current portion of royalty obligation
Forward foreign exchange contracts Peso	$	814	$	—	$	—	$	—	$	—
Forward foreign exchange contracts Canadian dollars	—		1,598		—		—		—
Palmarejo gold production royalty	—		—		—		37,279		84,285
Put and call options, net	—		1,551		2,981		—		—
Concentrate sales contracts	71		512		—		—		—
	$	885	$	3,661	$	2,981	$	37,279	$	84,285

	December 31, 2012
	Prepaid expenses and other		Accrued liabilities and other		Other long- term Liabilities		Current portion of royalty obligation		Non-current portion of royalty obligation
Forward foreign exchange contracts Peso	$	376	$	300	$	—	$	—	$	—
Palmarejo gold production royalty	—		—		—		41,146		103,952
Put and call options, net	—		2,025		7,274		—		—
Concentrate sales contracts	1,030		163		—		—		—
	$	1,406	$	2,488	$	7,274	$	41,146	$	103,952

The following represent mark-to-market gains (losses) on derivative instruments for the three months ended March 31, 2013 and 2012 (in thousands):

		Three months ended March 31,
Financial statement line	Derivative	2013			2012
Sales of metal	Concentrate sales contracts	$	(1,755	)	$	1,336
Production costs applicable to sales	Forward foreign exchange contracts	627			(783		)
Fair value adjustments, net	Forward foreign exchange contracts MXN Peso	738			2,690
Fair value adjustments, net	Forward foreign exchange contracts Canadian dollar	(1,598		)	—
Fair value adjustments, net	Silver ounces receivable	—			359
Fair value adjustments, net	Palmarejo gold royalty	14,429			(25,611		)
Fair value adjustments, net	Put and call options	4,228			(551		)
		$	16,669		$	(22,560	)

Please see Note 4 - FAIR VALUE MEASUREMENTS for additional detail on the fair value amounts for derivatives.

Credit Risk

The credit risk exposure related to any potential derivative instruments is limited to the unrealized gains, if any, on outstanding contracts based on current market prices. To reduce counter-party credit exposure, the Company deals with financial institutions management deems credit worthy and limits credit exposure to each. The Company does not anticipate non-performance by any of its counterparties. In addition, to allow for situations where positions may need to be revised, the Company deals only in markets that management considers highly liquid.