Central Bank Gold Leasing

The salespeople of the gold investment industry publish a lot of bold claims about central bank activities in the gold market (for example, here) along the lines of “All central banks want to suppress the gold price.“, “The central banks have secretly leased and sold most of their gold.” The present article is an attempt to summarize the facts that we know and to offer a rather different interpretation.

Advertisement

GLD – The Central Bank Of The Bullion Banks

The black curve (left scale) of the following chart shows the London pm gold fixing in U.S. dollars from 1 January 2006 to 30 April 2012. During the light-blue intervals which span about 35% of the entire period, the gold price increased at an annualized rate of 41.1%. During the remaining intervals, the price increased only at an annualized rate of 7.9%. The light-blue intervals are the result of a trading algorithm whose buy signals are indicated by the green dots and whose sell signals by the red dots.

GLD Inventory Strategy from 1 January 2006 to 30 April 2012

In this article, we explain how the signals can be computed from the variations of the inventory of the SPDR Gold Shares exchange traded trust (NYSEArca:GLD). We explain why the inventory adjustments can hardly be caused by price arbitrage between the GLD share price and the loco London spot price alone. We rather claim that bullion banks finance their inventory by lending it or selling it to GLD investors and that bullion banks manage their physical reserves by accessing the physical gold inside GLD.

The fact that a certain type of inventory adjustments has predictive power, supports the idea that large inventory changes are the result of active reserve management. This provides us with a unique window into the flow of physical gold that is usually obscured by the dominance of paper gold trading. A similar, but somewhat less robust result is shown for the iShares Silver Trust (NYSEArca:SLV).

WARNING (April 2013): This article uses the term buy signal in a technical sense. It does not mean that you ought to buy anything without understanding what you are doing. Notably, the rapid price increases after the buy signals have been absent since the fourth quarter 2012. Now you might dismiss the trading algorithm as a statistical fluctuation. Alternatively, you can wonder whether something might have changed.

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.