10 October 2008

Bank hoarding pushes up gold borrowing costs

The cost of borrowing gold has surged to its highest level since May, 2001 as central banks appear to be hoarding the precious metal.

The one-month lease rate for gold has soared more than threefold, to 2.68 per cent, in just over a week and the parabolic move - symbolic of the expanding reach of the credit crunch - has experts labelling it another bullish sign for bullion. Prices continue to hover around $900 US an ounce after rising 22 per cent in the past year.

"This (the lease rate for gold) usually precedes a sharp move in the gold price," said Steven Isenberg, chief executive officer of Toronto-based M Partners. The cost of borrowing gold rose dramatically in March, 2001, on signs that central banks were making less bullion available to speculators, mining companies and jewellers. This helped gold rally more than 12 per cent in the following two months.

Gold leasing rates also spiked, to nearly 10 per cent, in September 1999 after European central banks pledged to limit lending and sales.

Ross Norman, director of TheBullionDesk.com, said the latest spike "is indicative of perhaps an even tighter market still yet to come." While gold miners and jewellery groups are the most frequent borrowers, central banks and those who are long gold are the traditional lenders.

There are concerns that banks are removing themselves from the market to reduce any counterparty risks. This is creating a situation much like the interbank lending market, where banks are unwilling to lend money to each other.

"While once considered a sterile asset, gold is now taking on a much more important role in a country's reserves," said John Ing, CEO of Maison Placements Canada Inc. "I think the central banks want to hoard what gold they have." If Iceland had gold, for example, he doesn't think it would be facing bankruptcy.

Central banks hold about 30,000 tonnes of the world's gold in their vaults - about 20 per cent to 25 per cent of above-ground inventory. The U.S. is the largest holder, at close to 8,100 tonnes, while Germany's Bundesbank, which ranks second, has said it would not sell any more gold as they watch other assets fall in value. Other European central banks have also reduced their sales of gold.

While this is partly a result of the much smaller market for hedging by gold producers, the demise of high-quality global financial institutions is also contributing to the squeeze. "Would you lend $100 for a $2 return?" Norman said.

While lease rates may climb when people are shorting precious metals, this doesn't seem to be the case right now. "You'd be pretty foolhardy to be shorting the gold market with the amount of turbulence out there at the moment, even though gold is pretty high," Norman said.

A physical shortage demonstrated by the "ballistic" demand for coins in the past few months has probably driven rates higher, but the fact many people have gold in their accounts is probably an even bigger factor, he suggested. Investors are likely allocating their bullion, which means it is physically set aside in a vault with their name on it. If the bank holding it fails, it can still be collected because the gold cannot be lent out. Sounds like the ultimate safe haven.

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