LIBOR Scandal And Its Effects On Gold And Silver Lease Rates

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Following the LIBOR scandal, we need to take a look at gold and silver lease rates, because lease rates are calculated as LIBOR - GOFO (London Interbank Offered Rate - Gold Forward Offered rate).

The London Interbank Offered Rate is the average interest rate estimated by leading banks in London that they would be charged if borrowing from other banks. GOFO is the interest we need to pay if we swap gold for U.S. dollars. Whenever GOFO goes down (or gold lease rates go up), it means people are craving to get their hands on gold. At the same time, when LIBOR goes up (or gold lease rates go up), it basically means the same: higher gold prices to come.

So what is this LIBOR scandal about? Basically it comes to this. Just recently, Barclays has been caught manipulating LIBOR and EURIBOR and was fined $US 450 million in total on 27 June 2012. They artificially lowered the LIBOR rate. It wasn't only Barclays. JPMorgan Chase, Bank of America, Citibank and Deutsche Bank were all involved and were recently sued by the city of Baltimore on LIBOR manipulation. As a result, central banks are trying to reform LIBOR.

So what is the magnitude of this artificial lowering of LIBOR? Nomura reported last week that from August 2007 to May 2010, Citibank reported its loan costs at just under 2.1%. But Nomura calculated Citibank's real rate at 3.6%, meaning the bank understated its borrowing expense by 42%. The difference between Barclays' reported and actual borrowing rate was just 6%. Nevertheless, we're talking about a difference of approximately 1% in LIBOR. This is very significant, especially on the gold lease rate. The understatement of LIBOR could mean that the gold lease rate is artificially suppressed.

Recently, we saw a very significant increase in gold and silver lease rates. As we know already, lease rates are the "interest rate" on gold and silver. It gives us an idea on the valuation of the precious metals. The higher the lease rate, the more valuable gold and silver is to the central banks, and the higher the cost will be to short gold and silver. For more information, you can read my previous article on lease rates here. For a decade, gold lease rates have almost always been under 1%, except in 2008 where gold lease rates went above 1%. If LIBOR rates were to be calculated differently in the future after a reform, I expect that LIBOR rates will be higher than today. This will have immediate impact on gold lease rates, and could spike precious metal prices as lease rates turn into positive territory.

We already see the gold and silver lease rate move upwards after the LIBOR scandal:

For silver (SLV) we saw that the 1 month rate went up more than for other maturities (Chart 1). From a historical perspective, we know that shorter maturities are a leading indicator against longer maturities. So I expect a gradual increase in lease rates in the future.

Chart 1: Silver Lease Rates

For gold (NYSEARCA:GLD), we saw that the 12 month lease rate made a new all time high (Chart 2). Soon, the 2 month and 6 month lease rate will move up higher as well.

Chart 2: Gold Lease Rates


LIBOR suppression has an effect on the gold lease rate. Because of this suppression, LIBOR has been manipulated lower than the GOFO, resulting in negative gold lease rates. A future reform in LIBOR will make an end to this suppression, and will have an impact on gold lease rates, possibly moving it upward. As this happens, the gold market will tighten and the gold price will increase.

Disclosure: I am long (GLD), (SLV), (AGQ), (PSLV), (PHYS).

This article was written by

Katchum profile picture
Albert Sung is the author of Correlation Economics, monitoring breaking economic news on a day to day basis. He started investing in 2008 because of the economic crisis and holds a masters degree in chemical engineering. Previously, he worked several years as a process engineer at Ashland, a competitor of Dow Chemical. Today, he works as a regulatory compliance consultant at J&J, but his real passion will stay in macro-economics. His experience in the chemical and pharmaceutical industry allows him to monitor the economy from a process engineering standpoint, analyzing macro-economic charts, correlations and trends.

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