Derivative Financial Instruments and Fair Value of Financial Instruments

9 Months Ended

Sep. 30, 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 September 30, 2013, a total of 156,493 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 6.3% and 4.2% at September 30, 2013 and December 31, 2012, respectively. The fair value of the embedded derivative at September 30, 2013 and December 31, 2012, based on forward gold prices averaging approximately $1,337 and $1,694 per ounce, respectively, was a liability of $62.0 million and $145.1 million, respectively. During the three months ended September 30, 2013 and 2012, mark-to-market adjustments for this embedded derivative amounted to a loss of $9.6 million and $23.4 million, respectively. During the nine months endedSeptember 30, 2013 and 2012, mark-to-market adjustments for this embedded derivative amounted to a gain of $83.1 million and a loss of $10.9 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 September 30, 2013 and 2012, realized losses on settlement of the liabilities were $5.6 million and $10.9 million, respectively. For the nine months ended September 30, 2013 and 2012, realized losses on settlement of the liabilities were $22.9 million and $35.0 million, respectively. The mark-to-market adjustments and realized losses are included in fair value adjustments, net in the consolidated statement of operations.

Foreign Exchange Contracts and Hedges

The Company periodically enters into foreign exchange contracts and hedges to reduce the foreign exchange risk associated with forecasted Mexican peso (“MXN”) operating costs at its Palmarejo mine. At September 30, 2013, the Company had MXN foreign exchange contracts of $24.0 million in U.S. dollars. These contracts require the Company to exchange U.S. dollars for MXN at a weighted average exchange rate of 12.55 MXN to each U.S. dollar over the next six months. 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. In addition, at September 30, 2013, the Company had outstanding call options requiring it to sell $24.0 million in U.S. dollars in exchange for MXP at a weighted average strike price of 15.06 MXP to each U.S. dollar if the foreign exchange rate exceeds the strike price. Further, at September 30, 2013, the Company had outstanding put options allowing it to buy $24.0 million in U.S. dollars in exchange for MXP at a weighted average strike price of 12.50 MXP to each U.S. dollar if the foreign exchange rate exceeds the strike price. The Company had a liability with a fair value of $1.3 million at September 30, 2013. The Company recorded a mark-to-market gain on these contracts of $0.1 million and a mark-to-market loss of $1.4 million for the three and nine months ended September 30, 2013, respectively. The Company recorded mark-to-market gains on these contracts of $0.6 million and $3.4 million for the three and nine months endedSeptember 30, 2012, respectively. These mark-to-market adjustments are reflected in fair value adjustments, net in the consolidated statement of operations. The Company recorded a realized loss of $0.1 million and a realized gain of $0.7 million in production costs applicable to sales during the three and nine months endedSeptember 30, 2013, respectively. The Company recorded realized gains of $0.4 million and realized losses of $1.5 million in the three and nine months endedSeptember 30, 2012, respectively, which have been recognized in production costs applicable to sales.

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 September 30, 2013, the Company had outstanding provisionally priced sales of $32.4 million, consisting of 0.1 million ounces of silver and 26,265 ounces of gold, which had a fair value of $31.7 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

At September 30, 2013, the Company had outstanding put options that expire December 31, 2013, allowing it to sell 1.3 million ounces of silver and 25,000 ounces of gold at a strike price of $17.00 per ounce and $1,200 per ounce, respectively, if the market price of silver and gold were to fall below the strike price. The fair market value of these contracts was a net asset of $0.2 million. During the three months ended September 30, 2013, the Company recorded unrealized losses on the contracts of $0.4 million.

At December 31, 2012, the Company had 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. The fair market value of these contracts at December 31, 2012 was a net liability of $9.3 million. During the nine months endedSeptember 30, 2013, 25,000 ounces of gold put options expired at a weighted average strike price of $921.60 per ounce and 12,500 ounces of gold call options expired at a weighted average strike price of $2,000, resulting in a realized loss of $1.1 million. During the three months ended September 30, 2013 and 2012, the Company settled the remaining 97,000 ounces of gold put options and 84,500 ounces of gold call options for a net realized gain of $0.4 million. During the three months ended September 30, 2013 and 2012, the Company recorded unrealized losses of $2.4 million and $3.6 million, respectively, related to the outstanding options. During the nine months endedSeptember 30, 2013 and 2012, the Company recorded unrealized gains of $9.3 million and $1.4 million, respectively, related to the outstanding options. The realized and unrealized gains and losses are included in fair value adjustments, net in the consolidated statement of operations.

As of September 30, 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	$	8,633	$	24,895	$	24,691	$	19,236
Average gold price in excess of minimum contractual deduction	$	502	$	498	$	494	$	490
Notional ounces	17,201		50,004		50,004		39,285
Mexican peso forward purchase contracts	$	12,000	$	12,000	$	—	$	—
Average rate (MXP/$)	$	12.90	$	12.20	$	—	$	—
Mexican peso notional amount	154,816		146,460		—		—
Mexican peso put options purchased	$	—	$	24,000	$	—	$	—
Average strike price (MXP/$)	$	—	$	12.50	$	—	$	—
Mexico peso notional amount	—		300,000		—		—
Mexican peso call options sold	$	—	$	24,000	$	—	$	—
Average strike price (MXP/$)	$	—	$	15.06	$	—	$	—
Mexico peso notional amount	—		361,500		—		—
Silver concentrate sales agreements	$	2,326	$	—	$	—	$	—
Average silver price	$	22.82	$	—	$	—	$	—
Notional ounces	101,908		—		—		—
Gold concentrate sales agreements	$	30,123	$	—	$	—	$	—
Average gold price	$	1,147	$	—	$	—	$	—
Notional ounces	26,265		—		—		—
Gold put options purchased	$	382	$	—	$	—	$	—
Average gold strike price	$	1,200	$	—	$	—	$	—
Notional ounces	25,000		—		—		—
Silver put options purchased	$	186	$	—	$	—	$	—
Average silver strike price	$	17.00	$	—	$	—	$	—
Notional ounces	1,250,000		—		—		—

The following summarizes the classification of the fair value of the derivative instruments as of September 30, 2013 and December 31, 2012 (in thousands):

	September 30, 2013
	Prepaid expenses and other		Accrued liabilities and other		Current portion of royalty obligation		Non-current portion of royalty obligation
Foreign exchange contracts Peso	$	9	$	1,355	$	—	$	—
Palmarejo gold production royalty	—		—		22,590		39,406
Gold and silver put options	160		—		—		—
Concentrate sales contracts	42		766		—		—
	$	211	$	2,121	$	22,590	$	39,406

	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
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 and nine months ended September 30, 2013 and 2012 (in thousands):

		Three months ended September 30,						Nine months ended September 30,
Financial statement line	Derivative	2013			2012			2013			2012
Sales of metal	Concentrate sales contracts	$	718		$	1,591		$	(2,037	)	$	2,050
Production costs applicable to sales	Forward foreign exchange contracts	(99		)	394			732			(1,540		)
Fair value adjustments, net	Foreign exchange contracts MXN Peso	100			621			(1,422		)	3,394
Fair value adjustments, net	Silver ounces receivable	—			280			—			302
Fair value adjustments, net	Palmarejo gold royalty	(15,279		)	(34,266		)	60,216			(45,771		)
Fair value adjustments, net	Put and call options	(3,104		)	(4,283		)	7,474			(2,647		)
		$	(17,664	)	$	(35,663	)	$	64,963		$	(44,212	)

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.