The Many Values Of Gold

The present article gives an overview of various ideas on how much an ounce of gold might be worth.

We know the price of an ounce of gold. Last week, on 3 February 2012, the price of gold was US$ 1734.00 per ounce (London pm fixing). So much about the price. But what is its value?

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Backwardation and Declining COMEX Inventory

Silver inventory at the New York Commodity Exchange (COMEX) is declining. Since the beginning of 2011, in addition to the overall decline, a lot of inventory has been shifted from the registered to the eligible category.

For much of 2011, the COMEX silver futures market has been in backwardation. Similarly, the London OTC silver forward market is in backwardation as reported by the London Bullion Market Association (LBMA). Figure 1 shows the Silver Forward Offered Rate (SIFO) from November 22, 2010, to May 19, 2011.

Figure 1: The LBMA Silver Forward Offered Rate (SIFO) 2010-2011

 
We see from Figure 1 that the contango of the LBMA silver forward market collapsed on January 19, 2011, and silver has been in backwardation ever since – with the exception of about 4-5 weeks in March and April. For more background, please take a look at Backwardation in The Case of a Monetary Metal.

In this article, I briefly explain why it is perfectly natural if

• COMEX inventories are declining,
• Silver is being moved from the registered to the eligible category,
• Silver deliveries occur as late in the delivery period as possible,
• Silver deliveries suddenly appear out of nowhere and are checked into the registered category only at the last minute before delivery,

as long as silver is in backwardation. None of these indicates that there is a shortage of physical silver or that there is a short speculator about to default.

Synthetic supply of gold?

In the comment section at FOFOA’s blog (see the messages by DP and Jeff), we had a discussion about whether you can create synthetic supply, i.e. a form of paper gold, using the futures markets such as the New York Commodities Exchange (COMEX).

In the following, I explain why I think the answer is no.

The Gold Forward Offered Rate (GOFO) – Fever Chart of the LBMA

Figure 1 shows the Gold Forward Offered Rate (GOFO) between January 1991 and December 2010 as published by the London Bullion Market Association (LBMA).

Figure 1: LBMA Gold Forward Offered Rate 1991 - 2001

 
GOFO is the interest we need to pay if we swap gold for US$, i.e. if we lend our gold and borrow currency, in this case US$, for the same fixed period. The LBMA publishes daily GOFO quotes for each of the periods of 1,2,3,6 and 12 months. These data are shown in Figure 1 above.

Whenever GOFO turns sharply lower or even negative, this indicates stress in the London gold market, i.e. that some of the participants are desperate to get their hands on gold on short notice and are prepared to pay a premium for borrowing gold against US$ collateral. GOFO is the (upside down) fever chart of the London gold market. As Figure 1 shows, the London gold market came down with a serious flu on several occasions: January 1993, November 1995, September 1999, May 2001, and November 2008. It caught a milder form of cold in September 1997, November 1997, March 1998 and September 1998.

In this article, we compile various pieces of information, including historical facts, articles in newspapers and market rumours in order to put the evolution of GOFO shown in Figure 1 into a broader context. We focus on November 1997, March 1998, September 1998, September 1999, May 2001, and October 2008. The article will appear in several parts. This is Part I.

Negative Lease Rates Revisited

The Gold Lease Rate (GLR) as reported by the London Bullion Market Association (LBMA) turned negative after the peak of the credit crisis in 2008. The GLR over 1,2 and 3 months stayed negative for most of 2009 and 2010.

LBMA Gold Lease Rate 2008-2010

 
Since nobody leases their gold without charging a fee, a negative GLR seems to be nonsense. So how come the LBMA reports consistently negative GLRs?

We show that in an efficient market, the GLR as reported by the LBMA is equal to the risk premium for the case that the leased gold is not returned minus the storage fees for the gold, and so it can indeed come out negative.

Another possible answer is that LIBOR may have been rigged. As of a week ago, US, UK and Japanese authorities were investigating several banks for allegedly having manipulated LIBOR, the London Inter Bank Offered Rate.

Bullion Banking with Alice and Bob

We are not long. We are not short. We just borrow and lend.

This is a sketch of how a bank might lend against a reserve of physical bullion. We look at a number of simplified balance sheets that illustrate the changes in the reserve ratio, and we point out the two main risks: bad loans and a run on the bank. This article contains nothing new. There are just a number of examples to illustrate the common transactions.

In future articles, we will ask what an owner of physical bullion can do in order to earn interest using his or her bullion, and how a bullion bank might try to defend against a run on their physical reserve.

Backwardation in the Case of a Monetary Metal

Silver has been in backwardation at the LBMA according to the published SIFO (Silver Forward Offered Rates) since January 19, 2011. It has also been in backwardation at the COMEX (New York Commodity Exchange) since around February 7, 2011. Figure 1 shows the LBMA Silver Forward Offered Rate from November 22, 2010, to May 19, 2011.

Figure 1: LBMA Silver Forward Offered Rate (SIFO) 2010-2011

 
I was dissatisfied with much of what has been written on this topic. This is an attempt of a better explanation.

Summary

I explain that silver should not be viewed as an industrial commodity that is consumed, but that one should rather view US$ and silver as a currency pair. If one takes this point of view, backwardation is not a market inefficiency due to a supply shortage, but rather indicates counterparty risk.

Update (27 February 2012): Backwardation is also possible if US$ deposits are subject to carrying charges or if nominal interest rates are negative, see Red Alert Update.