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Gold Lease Rate 101

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Increasing numbers asking questions about gold lease rates. Allow me to shed some light.

 

The biggest source of gold liquidity in recent times has been the central banks. Central banks have been very keen to pick up yield, any yield, on their large gold holdings. The traditional counter to this lending pressure is the borrowing by gold producers - price hedging by another name. Of course the producers stopped hedging a while ago given the bull run in gold. In fact they're all unwinding hedges. This meant all the traffic has been one way. The central banks have been lending to the bullion banks like Barclays, Deutsche, Goldmans, UBS at silly low rates like 0.05%.

 

Forward to credit crunch. Guess what...they don't want to lend to insolvent investment banks anymore. Not at 0.05%, not at 2%, not at 10%, not at any rate. They have turned the taps off. Meanwhile physical gold uptake by the Indians continues unabated year in year out. Now you have the demand for coins. There is a REAL liquidity issue out there now.

 

The market benchmark for gold lease rates is LIBOR-GOFO. This has been setting at 0.30% approx for most of the year. On Friday this fixed at 1.66%. It's going higher. And remember the actual lease rate is even higher, more like 2.75% because as we all know LIBOR is ridiculously low.

 

Lease rate curve is now inverted. Price backwardation is coming.

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... Lease rate curve is now inverted. Price backwardation is coming.

I think this is something James Turk predicted a long time ago. It's basically a sign that TSHHTF.

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Increasing numbers asking questions about gold lease rates. Allow me to shed some light.

 

The biggest source of gold liquidity in recent times has been the central banks. Central banks have been very keen to pick up yield, any yield, on their large gold holdings. The traditional counter to this lending pressure is the borrowing by gold producers - price hedging by another name. Of course the producers stopped hedging a while ago given the bull run in gold. In fact they're all unwinding hedges. This meant all the traffic has been one way. The central banks have been lending to the bullion banks like Barclays, Deutsche, Goldmans, UBS at silly low rates like 0.05%.

 

Forward to credit crunch. Guess what...they don't want to lend to insolvent investment banks anymore. Not at 0.05%, not at 2%, not at 10%, not at any rate. They have turned the taps off. Meanwhile physical gold uptake by the Indians continues unabated year in year out. Now you have the demand for coins. There is a REAL liquidity issue out there now.

 

The market benchmark for gold lease rates is LIBOR-GOFO. This has been setting at 0.30% approx for most of the year. On Friday this fixed at 1.66%. It's going higher. And remember the actual lease rate is even higher, more like 2.75% because as we all know LIBOR is ridiculously low.

 

Lease rate curve is now inverted. Price backwardation is coming.

 

spoon whereaouts can lease rates be found? Is there any historical data available? I read on Silveraxis that the LBMA was temporarily suspending lease rate publication due to problems with LIBOR

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Increasing numbers asking questions about gold lease rates. Allow me to shed some light.

 

The biggest source of gold liquidity in recent times has been the central banks. Central banks have been very keen to pick up yield, any yield, on their large gold holdings. The traditional counter to this lending pressure is the borrowing by gold producers - price hedging by another name. Of course the producers stopped hedging a while ago given the bull run in gold. In fact they're all unwinding hedges. This meant all the traffic has been one way. The central banks have been lending to the bullion banks like Barclays, Deutsche, Goldmans, UBS at silly low rates like 0.05%.

 

Forward to credit crunch. Guess what...they don't want to lend to insolvent investment banks anymore. Not at 0.05%, not at 2%, not at 10%, not at any rate. They have turned the taps off. Meanwhile physical gold uptake by the Indians continues unabated year in year out. Now you have the demand for coins. There is a REAL liquidity issue out there now.

 

The market benchmark for gold lease rates is LIBOR-GOFO. This has been setting at 0.30% approx for most of the year. On Friday this fixed at 1.66%. It's going higher. And remember the actual lease rate is even higher, more like 2.75% because as we all know LIBOR is ridiculously low.

 

Lease rate curve is now inverted. Price backwardation is coming.

 

I'm still trying to workout who is borrowing gold to push the lease rates so high over the last week or two, anyone got any ideas?

 

edit..

 

I've re-read your post, are you saying that the central banks are pushing up the lease rates because they don't want to lend gold, so the rise in the the lease rates isn't due to increased demand?

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I've re-read your post, are you saying that the central banks are pushing up the lease rates because they don't want to lend gold, so the rise in the the lease rates isn't due to increased demand?

That's the way I read it too. No-one wants to lend each other cash, hence LIBOR being high. But now equally no-one wants to lend each other gold. You might not get it back, after all.

 

 

 

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Isn't it a little more in depth than this, doesn't price backwardation in PM's mean that the lender can't earn money on leasing the PM? So more a question of can't rather than won't.

 

Lease rate curve is now inverted. Price backwardation is coming.

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Alan Greenspan himself referred to the federal government's power to manipulate the price of gold at hearings before the House Banking Committee and the Senate Agricultural Committee in July, 1998: "Nor can private counterparts restrict supplies of gold, another commodity whose derivatives are often traded over-the-counter, where central banks stand ready to lease gold in increasing quantities should the price rise." [Emphasis added].

 

http://www.house.gov/paul/congrec/congrec2002/cr021402.htm

 

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Hi all,

 

Massive fall in gold lease rates this week. Views on the meaning of this?... Prelude to a further sell off? Or simply indicative of LIBOR easing a bit? Or of recent and anticipated interest rate cuts?

 

 

Wanderer

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Yes, that's where I would look to (or the LBMA). Don't see anything unusual. Just normal (or almost less than normal) volatility.

 

Seems relatively high still to me (Au). Silver seems to be rising steadily.

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Seems relatively high still to me (Au). Silver seems to be rising steadily.

Oh, yes. Normal at this now higher level.

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Since there was apparently a misleading article recently on this:

 

Misinterpretation of Gold Lease Rates

http://goldchat.blogspot.com/2008/10/misin...ease-rates.html

 

Regrettably for Brian, it is GOFO, not the Lease Rate. How can I be so sure? Well when I worked in the Perth Mint’s Treasury and we borrowed gold, we were charged the Lease Rate, not GOFO. But don’t take my word for it. I quote from a booklet titled “A Guide to the London Bullion Market” issued by the London Bullion Market Association (who you would think would know what they are talking about): “Forward rate = Dollar interest rate – metal lease rate”

 

Therefore the fact is that it is GOFO which represents the “amount that can be earned from the gold carry trade”. GOFO is the measure of the net difference, “the amount that can be earned from the gold carry trade”, not the Lease Rate.

 

ie

 

GOFO = LIBOR – Lease Rate

 

Gold_and_GOFO_91to08.gif

 

 

 

I think this is better, and far too extensive for me to read right now:

 

IMF: Gold Leases, Loans, Swaps and the Gold Forward Rate

27 October 2008

http://jessescrossroadscafe.blogspot.com/2...s-and-gold.html

 

To test the validity of this view, it is useful to look at how gold lease rates are determined in the market:

 

Gold lease rate = LIBOR - GOFO rate

 

LIBOR is the London Inter-Bank Offered Rate, a widely used international risk-free interest rate.

 

The GOFO rate is the Gold Forward Offered rate, which is the rate at which contributors (the market making members of the London Bullion Market Association) are prepared to swap gold against US dollars.

 

The charts below show the daily gold price and the daily one year LIBOR, GOFO, and gold lease rates over the past seven years.

 

Gold_Lease_GOFO_LIBOR_98to04.gif

 

The relationship of LIBOR and the GOFO rate to the lease rate is shown in Chart 2.

Comparing Chart 1 and Chart 2 shows that the gap between GOFO and LIBOR is significant in times of falling gold prices, and GOFO approaches LIBOR in times of rising gold prices.

 

The composition of the lease rate supports the view of the components of a gold loan outlined above. The payment of interest indicates the existence of a loan and the use of the GOFO rate indicates the existence of a gold swap.

 

 

Conclusion

 

The topic of this paper is the treatment of the lease payments on gold loans. The analysis of the positions and the flows has been done together as it is not possible to draw conclusions on the nature of the flows without looking at the positions to which they relate.

 

The description of components of a gold loan in this paper is likely to be controversial given the state of the overall debate on reverse transactions, but it is hopefully a useful contribution to that debate. The empirical support lent by the derivation of the lease rate, that is that the loan is seen by those setting the rate as a loan and a swap, may prove useful in that debate.

 

The conclusion on the nature of the lease payments is that they are the net of two flows, interest on a loan and transactions in a financial derivative or margin payments on a forward contract.

 

These should be recorded separately.

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I don't think this is here yet (maybe missed it!) but a VERY nice explanation of GOFO,Libor etc:

http://cij.inspiriting.com/?p=530

 

GOFO- according to the London Bullion Metal Association, the GOFO is the

 

Gold Forward Offered Rate. These are rates at which contributors are prepared to lend gold on a swap against US dollars. Quotes are made for 1-, 2-, 3-, 6- and 12-month periods.

 

GOFO is basically the interest rate for borrowing money using gold as collateral. For example, a central bank will enter a swap position with a bank by swapping its gold for US dollars with the bank. At the end of the period, the swap has to be reversed with the central bank paying an additional certain percentage above the original amount of US dollars. That “certain percentage” is the GOFO rate. The GOFO rate is related to the gold futures price. This is because if the GOFO rate is too much higher than the gold futures price, then the central bank will be better off selling the gold in the spot market and simultaneously buy gold futures.

 

LIBOR- this is the London inter-banking lending rate

 

Derived Lease Rate (DLR)- this is the lease rate that you see quoted at Kitco.com.

The DLR is defined as LIBOR - GOFO.*

 

Now, this is where it is getting complicated. So, we’ll use an example. Let us suppose, this is the current situation:

 

LIBOR- 5%

GOFO- 1%

DLR- 5 - 1 = 4%

Gold price- $1000/oz

 

Let’s say Bank A has 100 oz of gold. It then enters a swap with Bank B. So, Bank A will end up with $100,000 and Bank B has 100 oz of gold. At the end of the period, Bank A has to pay $101,000 to get back its gold. Now Bank A invests the $100,000 in the market markets and receives LIBOR interests. At the end of the period, it will have $105,000. Then it pays $101,000 to Bank B to get back its gold. The net ‘profit’ in this transaction is $4000, which is 4% of the original total gold purchase price.

 

The net effect of these transactions is this: Bank A lend gold at 4% lease rate. To end it all, the lease rate, as explained in Kitco.com is:

 

The lease rate is the cost of borrowing gold. In much the same way that individuals borrow dollars, pay an interest charge, and then return dollars to the lendor, gold bullion participants will borrow ozs of gold, pay a borrowing cost, and return the ozs of gold to the lendor. The debt is measured in terms of ozs as opposed to dollars. The value of the metal when it is being borrowed or returned is not a factor.

 

* so when GOFO is negative, DLR=LIBOR- (-ve number)

-->DLR is higher than Libor in this situation.

 

And indeed, Kitco's 1,2 Month lease rates are higher than Libor today/yesterday.

USD 1M Libor: 1.39875%

Kitco 1M DLR: 1.48%

 

DLR=Libor-Gofo so GOFO = -0.081%

 

Thanks, all, esp CGNAO + Steve - I think I understand it now :)

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