Wednesday, May 23, 2012

The relationship between gold lease rates and gold price

Since the post on gold lease rates back in December, a number of Sober Look readers have asked whether there is a long-term relationship between gold lease rates and gold price. Based on the weekly data available, there is none. The scatter plot below shows weekly moves in gold futures price vs. weekly moves in 3-month gold lease rates since 6/29/2007.

Source: Bloomberg

The R-squared, which shows the proportion of variance in gold price explained by moves in lease rates is 0.008. Daily data shows no significant relationship between the two either.

One would think that higher lease rates should provide support to gold price because a commodity that could be leased at a higher rate should be worth more. But that assumption is not supported by the data. In fact the recent moves demonstrate somewhat of an inverse relationship.

Recent data (source: Bloomberg)

The rationale for this inverse relationship is fairly simple. As more investors put short positions on, there is higher demand to borrow the metal (one needs to borrow an asset in order to short it), driving up lease rates. Many gold investors have been shorting gold using forward or futures markets to hedge their holdings. But dealers who buy forwards from these investors end up shorting physical gold to become neutral. The end effect is the same - large volumes of gold shorting should translate into higher lease rates. The recent weekly data shows a correlation of -0.6 (R-squared of 0.4).

Recent data (source: Bloomberg)

Whether this recent relationship holds going forward remains unclear. But based on historical data, the correlation should revert back to zero over the long run.
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