What You Know and What You Don't Know About Gold

Take a look at the daily charts of Gold. If you are a strong believer that the USD and Gold, depsite unpegging from each other, still enjoys a healthy inverse relationship then you will be surprised. Gold seems to be on a temporary downtrend while the US Dollar Index is trading within a range. I admit i do not have the experience to tell if this trend will prolong over the months of years but one thing is for sure, such radical movements in gold price is definitely not rational. On the long run, i expect gold to rise again for the fact that to mend the U.S trade and current account deficits, the USD has to weaken and thus making U.S exports more viable for the global community.

So what triggered such a huge selloff in gold within the months? Read the following and decide if that might be the cause. No one will know except the market mover himself =)

The Gold Lease or Gold Libor Rates
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From: http://www.aci.net/kalliste/gold3.htm

Gold bears interest. Positive interest. Many people do not know this. They are used to the notion of storing their gold with some bank or warehouse, and paying for storage cost. They then view the storage and insurance cost as a negative interest rate. But this has little to do with the way gold is priced or traded in the wholesale market.

The forward price of gold--the price agreed now for gold to be purchased or sold at some time in the future--is a function of the gold spot price, and the interest rates representing alternative uses of resources over the forward time period. So before we discuss gold forward prices, we should discuss gold and dollar interest rates.

This brings us to the gold lease rate, or the gold interest rate paid on gold deposits. Another term that is used is gold libor, by analogy with the London Interbank Offered Rate for eurocurrencies traded in London. Despite the apparent literal connotation of each of these labels, "gold libor rates" and "gold lease rates" are alternative descriptions that refer to the bid-asked gold interest rates paid on gold. The bid rate (deposit rate, borrowing rate) is the gold interest rate paid for borrowing gold (that is, on gold deposits), while the asked or offered rate is the gold interest rate quoted for lending gold. The expressions "bid-asked gold lease rates" or "bid-asked gold libor rates" are thus interchangeable.

If the gold borrowing rate is 2 percent per annum, for example, then 100 ozs of gold borrowed for 360 days must be repaid as 102 ozs of gold. (Gold interest rates, like most money market rates, are nearly always quoted on the basis of a 360-day year.) In the early 1980s gold deposits rarely yielded over 1 percent, but in recent years have rarely yielded less than 1 percent.

Because of large central bank gold holdings, gold loans are one of the cheapest financing sources for the gold mining industry. A mining company borrows gold and sells it on the spot market to obtain funds for gold production. The interest installments on the gold loan are payable in gold. And when the loan matures, the principal (and any final interest due) is repaid directly from mine production.

Central banks are the major lenders of gold. They accounted for around 75 percent of the gold on loan, estimated at around 2,750 tonnes, at the end of 1996. Central banks in recent years have been under pressure to earn a return on their gold holdings, and therefore lend to, for example, gold dealers who have mismatched books between gold deposits and gold loans. (The practice of central bank gold lending first became newsworthy in 1990, when the investment banking firm Drexel, Burnham, Lambert went bankrupt while owing borrowed gold to the Central Bank of Portugal.)

The gold lending (or borrowing) rate, then, is one of the components that determine the gold forward price. Let's see how this works.