14 December 2011

The LIBOR-Gold Forwards Pain Index - Gold Lease Rates Plunged - More Than Meets the Eye

This is the reason for the ferocity of this sell off in my judgement, coupled of course with a general liquidation in stocks and other 'risk assets.'  I cannot help but notice that despite the message of panic, the SP futures remain in a fairly well defined trading range that goes back to late October.  The lower bound of its triangle is around 1180.

Maybe things will fall out of bed, and Europe will topple, but right now I smell a skunk.  And it is likely the offspring of BB and TG.

Central Banks were leasing gold for record low rates to the bullion banks like JP Morgan and HSBC. Silver lease rates also fell in sympathy.

As you may recall, LIBOR - GOFO (Gold Forward Offered Rates) = Lease Rate.

As can be seen from the last two charts showing the LIBOR GOFO spread, the lease rates reported in the press are a derived rate and actually represent the amount that can be earned from the gold carry trade.

I do not like to look at just the Lease Rate which is really just a calculated derivative like the 'spot price' based on the present value of the futures front month,  but at the two major components that constitute it.  Which one is driving the change in the spread, and why? 

As an aside, I do not think that the major bullion banks finance their gold leases through LIBOR anymore in these days of excess reserves and quantitative easing, but it is a useful reference for most others.  This tends to put a little more emphasis on the nominal level of the Gold Forwards Offered Rate.  But this is just my opinion and I could be wrong.

There is an obvious 'chicken and egg' argument embedded in this phenomenon.  For example, some might say that the high spread between GOFO and LIBOR makes it difficult for those who wish to short gold to obtain it since the price one pays to finance the deal is quite high.  I think this is Tom McClellan's hypothesis as well as some others. 

This is an interesting theory, because it seems to suggest that without the ability to borrow gold from central bank holdings and perhaps those others who can lease in large numbers like ETFs and not the spot market, shorting gold is not possible at these prices and the natural tendency of the clearing price is to stay the same or to increase.  This suggests more manipulation than market demand and supply.

I tend to think that the spreads widen as the bullion banks must borrow more heavily to support their short positions with some sort of physical backing.  When the pain of the spread becomes too great, they have the incentive to throw contracts at the paper price in a desperate effort to break the price and relieve the short term pressures. 

The 'informational campaign' by the bankers demimonde that surround these bear raids seems to support this hypothesis of a 'market operation.' The central banks are notorious for rescuing Primary Dealers who are in trouble.

I would tend to categorize this latter theory of mine as the LIBOR-Gold Forwards Pain Index.

But unfortunately I can see both sides of these theories.  I would just like to know who is motivated by leasing their gold in order to knock the price for some reason.  I know of only two groups like that:  the fiat central banks in order to help the bullion banks, and perhaps unallocated ETFs that do not particularly care what the price of gold may be as long as they can collect their fees.

"Nor can private counterparties 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."

Alan Greenspan, Congressional Testimony on Regulation of OTC Derivatives, 24 July 1998

The bullion banks use this leased gold as collateral for more fractional paper short sales, breaking the price trend and forcing liquidation. Their sales are done in the so-called Dr. Evil manner, of dumping large numbers of contracts on light markets.

There is also the liquidation factor from the collapse of MF Global, and the reluctance of small specs to engage in the futures markets at all because of capital risk and lack of confidence.

This allows the bullion banks to arrange for a big price swing that allows them to cover their short positions and also obtain other assets on the cheap such as mining companies.

Since the leased gold must be returned after a short term period, this is almost always a trading gambit, as opposed to outright net gold sales by the central banks which have virtually stopped in the past couple of years.

This at least is my take on what is happening. If this is correct we could see a repeat of the big market bottom and deep lows with a spring back as we have seen several times before.  And the magnitude of these swings may continue to increase as the sorcerer's apprentices continue to meddle with the real economy.

If the CFTC were to do their jobs, as the Europeans had done with banks like Citigroup who employed their 'Dr. Evil' trading strategy there, we would not have this type of harmful volatility in key commodity markets.

On these dips one would imagine that long term buyers are taking advantage of the low prices to acquire bullion and store it as a future hedge. As the bullion banks seek to return the borrowed gold, their demand attracts the momentum trading hedge funds that are now selling, so we see a big rally in the metals.  The big rally in the metals causes the LIBOR - Gold Forwards pain to increase, and so the banks cry to be rescued.  And so on it goes on, until something breaks.

The obvious artificiality of these price swings obscures the efficient allocation of capital, and the orderly operation of markets, not only in metals but in key commodities significant to the real economy. The CFTC and SEC apparently have the tools to correct this, but they choose not to do anything constructive for whatever reasons.   Cronyism and Congressional opposition are two possible motives.

This is not dissimilar from the gaming of the energy markets that Enron made infamous before its collapse. Financial structures based on this sort of artificial con game always collapse, given time and the latitude for their greed made possible by regulatory capture.

That is why the public should have no patience with the commodity market makers like MF Global, a TBTF bank, and even an exchange when they fail because of reckless gambling and market manipulation.

As for any complicit central bankers, regulators, and politicians, justice must be restored and prosecutions made in order to halt the growth of the moral hazard of complicity in fraud and insider trading that is now endemic, if not epidemic.

Gold Lease Rate Slides to Lowest on Record as European Banks Seek Dollars
By Nicholas Larkin
Dec 8, 2011 10:55 AM ET

The interest rate for lending gold in exchange for dollars plunged to the lowest on record this week as European banks sought ways to secure the U.S. currency amid the region’s debt crisis.

The one-month lease rate on gold fell to minus 0.57 percent on Dec. 6, the lowest according to Bloomberg data going back to January 1998. The rate, derived by subtracting the gold forward offered rate from the London Interbank Offered Rate, was at minus 0.56 percent today and compares with minus 0.23 percent at the start of this year. A negative reading means banks have to pay to have their gold deposits lent.

The rate at which London-based banks say they can borrow for three months in dollars rose to the highest level in almost 2 1/2 years yesterday, even after the Federal Reserve and five other central banks agreed on Nov. 30 to cut the cost of providing dollar funding. Gold has climbed 21 percent in London this year and reached a record $1,921.15 an ounce on Sept. 6 as investors and central banks boosted holdings to protect wealth.

“European banks especially are having liquidity funding problems, which does see a lot of lending of gold and that’s putting downward pressure on lease rates,” Walter de Wet, head of commodities research at Standard Bank Plc in London, said today by phone. “Funding problems will continue for a while.”

All figures in these charts are priced in US dollars and are from the LBMA. The cumulative gold price is the daily change between London PM fixes.