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Analysts: GOFO, Lease Rates Hinting At Tightening Gold Market

By Allen Sykora Kitco News
Thursday November 13, 2014 12:35 PM

(Kitco News) - Gold forward offer rates, commonly referred to as GOFO rates, have hit a 14-year low, implying some tightness is developing in the gold market, traders and anlaysts said.

“The GOFO rate, by itself on its face value, is at the tightest level it’s been at since 2000,” said Kevin Grady, veteran gold trader and owner of Phoenix Futures and Options. “There is definitely some tightness in the market. There is definitely some physical buying out there. The question is whether it’s some hedging going on or some consumers and jewelers doing some buying.”

HSBC, in a late-Wednesday research note, pointed out that the one-month GOFO rate fell to a negative 0.2025 from the previous session’s negative 0.1850. The GOFO rate is the rate in which gold can be swapped for U.S. dollars, the bank explained.

“A negative rate implies that a counter party with a long position on gold can borrow money against their gold holdings at a better rate than that from the LIBOR
market,” the bank said. “This suggests that physical demand for the yellow metal has outpaced paper demand. Physical buyers have responded positively to cheaper prices despite continued liquidations from the gold exchange-traded funds.”

Natixis, in a Thursday research note, pointed out that for the past two weeks, GOFO rates have gone into negative territory, lifting the one-month gold lease rate from around 8 basis points to a high of 34 basis points, the highest level since 2009.

The firm described a change in the structure of the market in which gold previously held in Western vaults, and therefore available for leasing, has been transferred to Asian households and investors.

“Last year, as the price of gold collapsed, substantial amounts of physical gold was moved from Western investors to Asian investors,” Natixis said. “Outflows from physically backed ETPs (exchange-traded products) – mainly held by Western investors – totaled 870 (metric) tons, while the shift to Asia was evident from strong import data as well as sharp increases in Asian gold premiums.

“Abundant holdings of gold during the financial crisis drove lease rates into negative territory, meaning that market participants were effectively paid to borrow gold. But these ETF outflows caused physical scarcity of gold in London, pushing lease rates into positive territory and thus making gold lending attractive once more.”

A similar situation has unfolded over the past few weeks, the firm said, pointing out that ETP holdings have fallen by 100 metric tons since the end of August. Further, Natixis said, premiums by Swiss refineries have risen to $1 an ounce with a two- to three-week waiting time. Also, data shows Chinese gold imports in September were the highest since April.

“This clearly suggests that gold sold by physically backed ETPs is once again leaving London and being melted into smaller 1kg (kilogram) bars preferred by the Asian market,” Natixis said.

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In its report, Natixis raised this question – when will the withdrawal of gold from Western vaults result in physical scarcity of the metal?

“So far, rises in lease rates have in large part been a reflection of the difficulty of transforming physical gold from Western-held bullion bars to kilo bars,” Natixis said. “At some point, however, this may become more a question of the absolute volumes of gold still held in Western vaults.

“The fact that lease rates rose by 30bps (basis points) in response to a switch of just 100 tons of gold over the past three months, versus a 40bp move in response to a switch of over 600 tons of gold in 2013H1, suggests that the physical availability of gold in Western vaults may soon become a more significant problem. As the amount of gold that is available for leasing dwindles, we should therefore expect greater volatility in gold lease rates.”

By Allen Sykora of Kitco News; asykora@kitco.com



Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.
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