Tag Archives: GOFO rates

The Gold Supply On The LBMA Is Extremely Tight

They can expand leverage [gold hypothecation, leasing, futures, forwards, derivatives] freely given the craven silence of the regulators and professional courtesy amongst the looting class. But they cannot create more physical bullion, and therein lies their limits.  – “Jesse” of Jesse’s Cafe Americain

The following commentary is just in case anyone was wondering about the existence of “backwardation” on the LBMA, which indicates that the immediate and near-term supply of gold (or silver) is extremely tight.   Backwardation occurs when the spot price of gold is above the future or forward price of gold.  It means entities that need or want gold immediately are willing to pay more now for gold rather than buy a futures contract or LBMA forward at a lower price  and wait for a delivery promised at a future date.

Conversely, it means that current holders of gold are unwilling or less willing to sell their gold now and buy a future/forward at a lower price.  They are unwilling to risk the possibility that they may not receive their gold at that future date.

In its essence, backwardation means that investors prefer physical gold over cash.  It also reflects a distrust of the ability of a seller of futures/forwards to deliver gold at the pre-specified date.

But the GOFO rate is an even better indicator of backwardation and scarcity of immediate supply of gold.  GOFO is probably the “purest” form of measuring the degree to which shortages exist because, unlike leasing, futures and forwards, the entity borrowing the gold from the lender has to put up full cash collateral.  It tells you that immediately available gold is not around and it reflects the fact the borrower is willing to not only pay interest on the gold borrowed (like leasing) BUT is willing to collateralize the valued of the loan 100% with cash.

GOFO transactions still occur and GOFO rates are available even though the LBMA intentionally stopped publishing the GOFO rates in January this year.  The following data was hypothecated from a Commerzbank daily report on the London bullion market:

UntitledYou’ll note that the GOFO rates are negative out to three months. This tells us there are shortages and expected shortages of available gold out to three months. The higher rate for 1 week relative to 3 months measures the relative tightness of the market but it also tells us the market is pricing in the probability that gold “might” become more readily available in 3 months. Take care of the problem now and worry about the future in the future.

You’ll also note that from September 22 to September 23 the GOFO curve became more negative.  This indicates that the market is growing even tighter.  Please note:  did not say that wholesale gold is not available in London.   But the GOFO rate tells us that the market is not only willing to pay a price to get its hands on gold now – the negative GOFO rate – but the market is also willing to collateralize that gold loan with cash.  The negative GOFO rate, in other words, reflects slight hints of desperation.

I would suggest that today’s $23 move up in the price of gold on Comex options expiry day – an event on which gold is usually slammed hard in the paper market – is a direct reflection of the growing scarcity of immediately available “wholesale” gold bars which can be purchased on the global market.

Gold Bullion Bar Backwardation Is Truly Historic

“Central Banks stand ready to lease gold in increasing quantities should the price rise.”  – Alan Greenspan, “The regulation of OTC derivatives,”  Before the Committee on Banking and Financial Services, U.S. House of Representatives, July 24, 1998

James Turk did an interview with Greg Hunter of USAwatchdog.com (interview link) in which he asserted that the current backwardation in the London gold bullion bar market is historically unprecedented.   In response to this, my friend and colleague “Jesse” of Jesse’s Cafe Americain asked me if this was indeed the case.

(For those who want a detailed explanation on what the GOFO is, please see this article I wrote last August:  What Is GOFO And Why It’s Now Bullish For Gold).

My first comment in response to Jesse was:  “First let’s define the “backwardation” to which he (Turk) refers.  The paper market, the Comex gold futures, is not in backwardation.   He’s referring to the LBMA negative GOFO, which is backwardation in the sense that someone is willing to pay money to borrow physical gold bars AND collateralize that loan with dollars.  This implies that physical gold in hand is worth more than the promise to deliver physical gold in the near future, which is backwardation.”

In terms of the relative scale of historicity that can be applied to this current period of backwardation, I knew that between now and last July the amount of time the GOFO rates have been negative was unprecedented since 1999.  But I went digging around for the historical data to define “historically unprecedented.”

It turns out that, going all the way back to 1989 (I can’t find any data prior to 1989, which is probably because gold leasing didn’t really go into full swing until then), there’s only been two other instances when the GOFO was negative.  It first occurred in the last two days of September 1999.  It lasted only two days.  The second time was November 20, 21 and 24, 2008.  The backwardation lasted for three days.

When the GOFO went negative last summer, it began in early July and lasted for nearly 3 months.  It went positive for a month then negative again for over two weeks (November).  It also spent half of December negative.  Since the beginning of 2014, the GOFO has been negative for 34 of the 81 days that the LBMA has been open.

Turk’s commentary (as always) in the interview linked at the top is well worth reading.  The implication of the long stretch of time in which the GOFO has been negative since last July is that,  despite being covered up by the extreme degree of price manipulation in the gold market using paper Comex futures, there is a severe strain on the ability of the bullion banks to deliver physical gold bullion into the massive accumulation by buyers in the eastern hemisphere.  At some point the amount of pressure building up – think of it as being the equivalent of trying to stuff a beach ball into a test tube – is going to result in a massive upside explosion in the price of gold.