01 December 2014

How historic is this negative GOFO?

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:
  • hold it
  • sell it
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.


  1. So Bron,
    Let me guess, you are not buying at these fire sale prices?

    Oh well. All the more for moi.

    Let's see, GOFO loses it's MOJO, Debt is soaring everywhere, and still some cannot recognize the writing on the wall.

    I wonder when the Mints will become "barbaric relics" and everyone simply uses digital fiat.


    Cheers, S. Rex

  2. Of course there are people shorting gold, they have a mandate for it. Miners suffer holding inventory with large price drops.
    One year from now you will likely wonder why you were drawn to question the here and now.
    "Truth, like gold, is to be obtained not by its growth, but by washing away from it all that is not gold." Tolstoy

  3. Hey Bron,

    Thanks, it's always good to have your counter punch on all things gold.

    Although I'm not sure if you realised but the LIBOR minus GOFO chart on the LBMA site is only showing up to 21 November atm when GOFO was only ~-0.25. GOFO is now ~-0.6. Making LIBOR minus GOFO around -0.7. So the move is roughly double the move you can see on the chart and the highest it since the financial crisis.

    And it's not like gold has been quiet since the crisis. We've been through a huge bull market, a big crash and transition to bear market. But now GOFO is making its biggest moves. I dunno what to make of it. I've had my theories for the past 2013/14 negative GOFO periods (which mostly occurred just before or just after the start of COMEX deliveries) but this one is not like the others.

    I thought it might be people wanting to pile on shorts before the swiss ref (knowing it would fail) but it's continued its decline today even after we know the results.

  4. Bron - how about a chart of the gold lease rate itself? that would shake out the apples and oranges and just leave something nice to analyze...

  5. I'm curious what Bron's positioning is - I think its pretty relevant to know whether you are LONG or SHORT gold with your personal positions.

    Everybody has an angle right? =)


  6. I think link below has the best explanation I have seen.

  7. I think that these moves in GOFO are indicative of trust in the financial system. I know that this statement is fuzzy/catchall type of observation.

    Counter-party and collateral risk are assuming a greater aspect in the current financial environment. As I see it, the sharp moves up and down were when there was either a “Thank God, we got the system fixed” or a “Good God, this sucker is going down” periods. This is all manageable when GOFO is securely in the positive zone. Short periods of negativity only concentrate the attention of the participants in rectifying (bandaids on top of bandaids is more my view) the situation.

    However, when you go negative as a trend it is more akin to the “marginal productivity of debt” situation. Then the negative rate starts to feed on itself just as more debt only exacerbates the problem. Then Gold will go no offer. The holders will only use it as collateral (under their own control) to acquire fiat to the extent that they need.

    So, if this negative GOFO period doesn't get “fixed” quickly, the negative GOFO could go parabolic to the downside. At that point, it isn't likely to stabilize at this -1% or -2%. The counter-party risk will become too great. At that point (or before) LBMA will stop quoting it just as they did SOFO. This doesn't fix it, it just means that LBMA (and participants” have put their fingers in their ears and said “I don't hear you”.

    I guess we'll see what happens.

  8. I agree, Anon's link just above is excellent - a must watch to the end.

  9. I wonder who's paying this shill to post such ignoramus article. Lol this guy should just put his foot where his mouth is and short the metal. Since he's so confident that the gofo rates are more negative due to an interest hike on the metal instead of the obvious reason that the metal contracts are being settled in cash because they can't satisfy demand . I'll emphasize. " There is no gold to satisfy the demand". When the sheep realizes this, they will have the floodgates construct a religious experience of epic proportions on these bankers.

  10. "...the only way to look through the effects of ZIRP is to look at gold's interest rate."

    Yep, I agree.

    Incidentally, the idea of a convenience yield is very similar to the gold lease rate. If you take the gold lease rate and add back storage costs you get the convenience yield. It equates to the pure reward that someone needs to compensate you with so that you are content doing without the conveniences of your gold for some period of time.

  11. I can bet you this. The bankers are losing control of their manipulated markets and they need an event to put the sheeples distraction back to rest. So what do you think they will do? You got it, a false flag. Look it up in the next 6months of 2015. They need to start a war with Russia and China or a false flag to lull the masses. People are catching on to their games and if people completely catch on, the will demand payment..... That payment will come in the form of blood. Bankers blood.

  12. "Another explanation may be that some gold businesses are very busy converting gold Westerners don't want into forms that Asians do"

    Bron - many months ago I recollect you saying in an interview that Perth Mint's gold, which used to flow to India now moves to China instead. Do I have that correct and if so, would you mind elaborating please? Especially in light of India dropping its 80:20 rule and what that means for their official imports moving forward.

  13. Anon, re "this shill" - don't you recognize independent and speculative commentary when you see it?

    It's not a black/white world. Even the insiders are bemused by the complex and inexplicable forces of their speciality.

    Go sit with Jake.

  14. Demand from China and India is so strong that it needs to be met by borrowed gold. This pushes gold lease rates up (GOFO down).

    In 2013 there was a lot of gold coming from ETF and other investments. Now it is much less, India imported over 150 tonnes in November, China imports are likely to be around the same number.

    In October when India was importing only 105 tonnes, gold deficit was at least 100 tonnes, Switzerland alone net exported 100 tonnes from its vaults. Because this gold deficit lasts already 3 months, it is probably a few hundred tonnes of borrowed gold now. This gold was probably borrowed for a short time and needs to be rolled.

    Selling borrowed gold means that someone is short this gold, it could be bullion banks or someone who sold paper hedges to bullion banks.

  15. So instead of going after Zerohedge, maybe just say you don't know as your last paragraph states. This was no helpful.

  16. I finally understood GOFO after reading the following article which also mentions your work Bron:

    What is your opinion on the conclusions therein?:

    GOFO leads LIBOR (by around three months).
    For reference, you can view the GOFO and LIBOR rates and charts here:
    Conditions for Bullion Bank Arbitrage:
    Selling gold certificates GOFO < LIBOR, No arbitrage GOFO = LIBOR, Buying back gold certificates GOFO > LIBOR

    “There is however one obvious risk in this business, namely that they get stuck with a full arbitrage book in a permanent backwardation – whereby they have sold (unbacked) gold certificates and the market never swings back into a contango to let them out.”

  17. Kid Dynamite – I’m having trouble uploading images, hence I didn’t post a lease rate chart, but you can generate one from the LBMA link.

    Spider – In my forced pensions savings (called superannuation in Australia) I allocate to gold and rebalance, I never short.

    Anon – I never said I was confident as to why GOFO was negative, just giving some additional reasons you won’t get anywhere else.

    Rowingboat – At this time we have seen renewed interest from India on the 80:20 rule dropping, for 9950 kilobars (not 9999) so we can expect to see some diversion of our output to India from China. Whoever pays the highest fabrication premium will get the gold. However I think should Indian deficit get too big they will just implement import quotas, so this may only be temporary.

    Tripodx – yep it certainly is inexplicable. I suspect the western bears who think golds technicals are weak and that being short was a sure thing are coming up against eastern physical demand, who don't care about TA or momentum, a real fight in the market on where gold should be.

  18. John Doegalt - these were my quick comments to Fraser in response to that article:

    “which carry none of the costs of holding physical gold The extra saving results in the arbitrage … Bullion Bank A has physical gold stored and insured at an annual cost of X%”

    The marginal cost to a bullion bank of storing physical gold is zero. http://goldchat.blogspot.com.au/2009/10/slv-and-jeff-nielson.html: “Important to note that the metal is not fully insured, just the first couple of billion (I don’t think the prospectus says anything about the first loss limit of the insurance). Once you get to a certain size therefore, the insurance cost is a fixed cost, not variable.” That fixed cost is paid for by holders of allocated and ETFs who pay part of their management fees to bullion banks for storage.

    “they create (out of thin air) certificates, sell them as promissory notes for gold and hedge their exposure in the futures markets and elsewhere, using all sorts of fancy techniques”

    So far so good. I would note here that the balance sheet of the BB is:

    Liability – 1oz unallocated owed to person X
    Liability - $1200 cash owed on long gold futures contract
    Asset – 1oz of long gold futures contract
    Asset - $1200 cash (from sale of unallocated gold to person X) some of which may be in held in a margin account

    Books balanced and no exposure to gold price. But then you immediately say:

    “As a base case, the profit comes from creating the certificates and leasing them out at GLR and then hedging their risk in the market by paying GOFO”

    Huh? You just said they SOLD the unallocated/promissory note/certificate, now you’re saying they leased the gold? That is a completely different type of transaction. In any case, if they leased gold to someone then their balance sheet would be:

    Liability – 1oz unallocated owed to person X
    Asset – 1oz loan to person X

    This is a balanced book and as a result the BB has no exposure to the gold price. In which case there is no need to “then hedging their risk”. Similar situation to this http://goldchat.blogspot.com.au/2014/02/fractional-reserve-bullion-banking-and_6.html, part of this series http://goldchat.blogspot.com.au/search/label/Fractional%20reserve%20bullion%20banking

    I stopped reading at this point as a BB doesn’t have to “hedge” gold loans.

  19. thanks Bron, I should have phrased my question better. What I meant was did Perth Mint mainly export to India b4 China entered the scene in 2011? Did most of the Perth Mint's gold go to India b4 2011/12?

  20. Yes, India was our main market. China was starting to build up then with the Indian restrictions that sealed it and China became the dominant destination.

  21. https://www.bullionvault.com/gold-news/gold-price-120520143

    "This week," says French investment and bullion bank Natixis, looking at wholesale gold borrowing costs, "one-month gold lease rates hit 0.73%, the highest level since the beginning of the financial crisis."

    But that jump in gold borrowing costs has swiftly receded, the bank notes, because "The sharp rally in gold prices on Monday resulted in a closure of short positions which in turn meant [bearish traders] no longer needed to borrow gold."

    London's Gold Offered Forward rate – an average of the incentive offered by would-be lenders to would-be borrowers of gold for cash swaps, known as GOFO – today rose back above zero for the first time in 6 weeks.

    That would suggest, says Natixis' note, either "new lenders, fewer borrowers, a release of supply that was previously not available for lending," or some combination.

  22. Bron- Ukranian gold enters the system.