So is this occurrence of negative GOFO a "Gold Shortage, Worst In 21st Century" as Zero Hedge recently claimed?
Keith Weiner
notes that by his strict definition of backwardation (a positive cobasis) there are now four futures contacts in backwardation when
"prior to this, the most we’ve seen is three". He considers this serious and suspects
"that this time, it’s a matter of price. We believe that when the price rises enough, this backwardation will subside".
JP Koning has an interesting
take, suggesting that negative GOFO is revealing the market's "convenience yield", a price businesses in the trade are willing to pay for
"uncertainty-shielding services". As he explains:
"Gold merchants seem to be anticipating choppiness in the future supply and demand of the metal, and see growing benefits in holding inventories of the stuff in order to cope with this choppiness. The convenience yield on these inventories has jumped to a high enough level that it currently outweighs the costs of storing and financing gold, resulting in an inverted gold market."
In contrast to Keith, JP notes that gold forward prices are only inverted
"over a narrow range of five or six-months. By mid-2015, forward prices return to their regular pattern of trading at a premium to current prices ... So no, gold is not becoming money. Rather, we are running into some short-term jitters, and merchants think that holding the stuff provides a few more ancillary benefits than before".
The more interesting part of JP's post for me, which leads us to an answer to my question, is his observation that
"earlier disruptions occurred when U.S. interest rates were already high enough that they continued to outweigh the metal's suddenly-augmented convenience yield. ... Going forward, all gold market disruptions could very well create sharp inversions of -1 to -2% in the 1 to 12-month horizons, insofar as we are living in an era of permanently low interest rates".
To explain JP's point, have a look at this chart from his post below.
Note the unusual chart pattern where GOFO moves up in a straight line from 2004 to mid-2006, is then flat for a year and a bit and then drops sharply over the next year and a half. I wonder what was going on in the gold market during that time to account for that behaviour?
For the answer go to
http://www.lbma.org.uk/pricing-and-statistics and select LIBOR in the chart drop down box. Isn't that amazing, US interest rates during 2004-2008 exhibit exactly the same chart pattern as GOFO.
In actual fact, there was nothing going on in the gold market. GOFO is mathematically equal to US Interest Rate minus Gold Interest Rate. Thus if US interest rates go up and Gold's Interest Rate is stable, then GOFO will rise. If you select "LIBOR minus GOFO" (ie, Gold's Interest Rate) in the LBMA's chart, you will see that it was indeed flat during 2004-2008.
If you look at that "LIBOR minus GOFO" chart you will see that while the interest rate on gold has moved up, it is not "historic", for which we would need to see interest rates above 2% (which at ZIRP would equate to circa -2% GOFO). The only reason current GOFO rates look historic is because cash rates are basically zero. Comparing GOFOs over time is not really comparing apples to apples - the only way to look through the effects of ZIRP is to look at gold's interest rate. It is like looking at cash interest rates during the 70s and 80s and noting how much better depositors were off compared to today because bank deposit rates were 15%, and completely ignoring the differing inflation rates between now and then.
This then leads on to the question of why would lease rates be rising (or it could be GOFO falling, it is hard to tell which market is in the driving seat sometimes)? I've said this a few times, but there are only two things you can do with borrowed gold:
For the first, JP's suggests that gold manufacturers and merchants are willing to pay to hold stock of gold to cover them for any future supply disruptions or choppiness. Another explanation may be that some gold businesses are very busy converting gold Westerners don't want into forms that Asians do, which would cause them to temporarily increase their working inventories. Another may be that bullion banks, who engage in
maturity transformation, have a liquidity mismatch and are needing to borrow gold to cover unallocated redemptions until their gold loans mature.
For the second reason, sell it, this basically means that people are shorting gold. It could be speculators, or maybe miners have resorted to hedging again (I note there was a 55 tonne increase in the global hedge book in Q2 2014). Consider that when miners
stopped hedging and started to reduce their hedges in 2002 that gold interest rates crashed to their current low levels.
So while Zero Hedge may spin a falling GOFO as bullish, it could be indicative of a rising interest rate on gold, which could be an indicator of short selling/hedging, which would result in a falling gold price. And what has gold been doing recently? I'm not saying this is the explanation, mostly likely all the explanations mentioned in the last two paragraphs are in play, we just don't know which is the main driver at this time, but at least here you will get some of the negative explanations to weigh up.
