Posts Tagged ‘GOFO’

How are gold lease rates quoted?

Sunday, August 31st, 2008

Back in Get paid to borrow gold and silver?, we mentioned that

But for a certain class of gold owners, they DO earn interests on gold. Right now, instead of receiving interest for lending out gold, they are paying people to borrow gold. Who are these gold owners?

They are the central banks. The ?interest rates? on gold is the gold lease rates…

One of our readers alerted us to this forum discussion, Anybody like to explain the negative lease rates:

Many people, even those that seem to understand the gold market seem to get confused on how the gold least rate is quoted… It is the LIBOR rate minus the gold lending rate for the duration quoted. Normally gold is loaned at less than LIBOR and that results in a positive figure for the lease rate (designated as GOFO by the LBMA).

Actually, that explanation from the forum is not accurate too. So, what are the gold lease rates all about and how are they quoted? We did some digging and found this commentary. To explain lease rates, we will start off with the definitions:

GOFO- according to the London Bullion Metal Association, the GOFO is the

Gold Forward Offered Rate. These are rates at which contributors are prepared to lend gold on a swap against US dollars. Quotes are made for 1-, 2-, 3-, 6- and 12-month periods.

GOFO is basically the interest rate for borrowing money using gold as collateral. For example, a central bank will enter a swap position with a bank by swapping its gold for US dollars with the bank. At the end of the period, the swap has to be reversed with the central bank paying an additional certain percentage above the original amount of US dollars. That “certain percentage” is the GOFO rate. The GOFO rate is related to the gold futures price. This is because if the GOFO rate is too much higher than the gold futures price, then the central bank will be better off selling the gold in the spot market and simultaneously buy gold futures.

LIBOR- this is the London inter-banking lending rate

Derived Lease Rate (DLR)- this is the lease rate that you see quoted at Kitco.com. The DLR is defined as LIBOR – GOFO.

Now, this is where it is getting complicated. So, we’ll use an example. Let us suppose, this is the current situation:

LIBOR- 5%
GOFO- 1%
DLR- 5 – 1 = 4%
Gold price- $1000/oz

Let’s say Bank A has 100 oz of gold. It then enters a swap with Bank B. So, Bank A will end up with $100,000 and Bank B has 100 oz of gold. At the end of the period, Bank A has to pay $101,000 to get back its gold. Now Bank A invests the $100,000 in the market markets and receives LIBOR interests. At the end of the period, it will have $105,000. Then it pays $101,000 to Bank B to get back its gold. The net ‘profit’ in this transaction is $4000, which is 4% of the original total gold purchase price.

The net effect of these transactions is this: Bank A lend gold at 4% lease rate. To end it all, the lease rate, as explained in Kitco.com is:

The lease rate is the cost of borrowing gold. In much the same way that individuals borrow dollars, pay an interest charge, and then return dollars to the lendor, gold bullion participants will borrow ozs of gold, pay a borrowing cost, and return the ozs of gold to the lendor. The debt is measured in terms of ozs as opposed to dollars. The value of the metal when it is being borrowed or returned is not a factor.