Lease Rates Tell Tales

Gold has long been available for lease. Recently, leased gold has played an important role in the practice by some gold mining companies of shorting their own product, to the detriment of shareholders. While this practice may have started innocently as a means to hedge risk in a down market, for some it quickly degenerated into an orgy of speculation, with some mines betting against as much as a decade of future production. By leasing gold very cheaply, then shorting it, they hoped to profit from the difference between today's price and a lower future price. Other participants in leasing include hedge funds, bullion banks, and others who seek to manipulate the market in order to protect these powerful interests who positioned themselves to profit from a continued decline in the price of gold.

These disgraceful practices, often discussed on the pages of Gold-Eagle and by crusaders such as Bill Murphy of the Gold Anti Trust Action League (GATA), have recently been exposed and discredited. Yet the market manipulation continues.

In his January 21st commentary, Murphy observed that gold lease rates are "the lowest I can recall" (see Figure 1).

Maybe so, but by graphing the data over time and noting correlations with recent events that are known to affect warehouse gold supplies, we may gain more insight about the gold market's dynamics. In fact, a graph may reveal additional predictive powers for the lease rate, far beyond those normally ascribed to it. We may be able to more accurately predict when the price of gold will lift off.

Although today's rates are indeed low, even more striking is the unusually wide and uniform spread between short-term and long-term interest rates: 0.56% for a one-month lease versus 1.7% for one year, with other rates distributed evenly between.

Notice that at certain times (right after the third Bank of England action, for example), the lease rates for various terms were "bunched up," with little difference between them. At other times (say, mid-October through mid-November of 1999), a substantial gap separated the one-month rates from any longer term.

Let us examine a hypothesis that might account for these differences: that lease rates express the probability of future gold availability. The probabilities are assigned by the most knowledgeable players: the bullion banks, central banks, and gold traders – the insiders. In effect, gold lease rates can give us an unprecedented window on the manipulators' inside knowledge.

Naturally short-term rates are usually lower than longer-term rates, because a lessor can more confidently predict the immediate future than the remote future. Movement of all rates down together indicates a copious supply that players think more than sufficient to meet anticipated needs. Upward movement as a group indicates a clear and present shortage of physical gold with no relief in sight.

Timing signals arise when rates diverge. Let's examine an example of divergence.

During the month leading up to the third BoE action on November 29th, it was widely known that 25 tonnes of gold would hit the market. Therefore, during November the one-month lease rates were exceptionally low at 0.74% (see Figure 3). Right after the auction, however, one-month rates joined the other lease terms averaging 1.85%. In fact, the one-month rates actually overshot a little to 2.13% before rebounding to 1.76% on November 30th.