8 October 2008

Profoundly bullish for Gold: Bullion lending by central banks all but dries up

Bullion lending by central banks all but dries up

London , Financial Times, 7 Oct 2008
Central banks have all but stopped lending gold to commercial and investment banks and other participants in the precious metals market, in a move that on Tuesday sent the cost of borrowing bullion for one-month to more than twenty times its usual level.

The one-month gold lease rate rocketed to 2.649 per cent, its highest level since May 2001 and significantly above its five-year average of 0.12 per cent, according to data from the London Bullion Market Association.

Gold lease rates for two, three and six months and for a year also jumped to levels not seen in the last seven years.

Traders said the jump reflects the fact that central banks – mostly European – have almost completely stopped lending gold in the last few days and are not rolling forward old leases after maturity. This is because of fears that some borrowers might not repay their bullion loans if they are engulfed by the financial crisis.

"A number of central banks have been cutting back on their gold lending," said Tom Kendall, a precious metals strategist at Mitsubishi in London.

John Reade, a commodities strategist at UBS, added that there had been a lot of talk about some central banks being unwilling to lend their gold because of a redoubled focus on the risk of borrowers not returning it.

"There is very little appetite for unsecured lending at the moment," he said.

Central banks usually do not ask borrowers to post any guarantee – or collateral – to secure bullion loans. "The key word now is safety," an official from a Europe-based central bank said.

In normal circumstances, central banks lend gold into the market – providing key liquidity – to earn a small return on what otherwise is a non-yielding asset.

Other factors are also pushing lease rates higher, including more investors' positions no longer available for lending, according to Philipp Klapwijk, chairman of GFMS, the London-based precious metals consultants.

Traders said the general dysfunction in money markets, with US dollar rates significantly higher, was contributing to volatile gold lease rates. Demand for physical gold and small and medium-sized bars had been strong, removing supplies from the market that otherwise could have been lent, traders added.

The US Mint onTuesday said it had run out of half-ounce and quarter-ounce American Eagle gold coins following "unprecedented" demand.

Gold prices on Tuesday rose $19.3 to $880.6 a troy ounce, having hit an intraday high of $890.6 an ounce. Bullion prices hit an all-time high of $1,030.8 in March. In euro terms, gold prices rose on Tuesday to a record high of €654.22 an ounce, above March's all-time high of €651.24 an ounce. It also hit a record in Australian dollars.

Investors are seeking refuge in actual gold coins and bars as fears about the safety of their savings increase. Some have even been selling their positions in gold futures, as this is a less tangible form of the metal. Since the collapse of Lehman Brothers three weeks ago, bullion prices have risen about 20 per cent.

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