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The best indicator that the physical market is becoming stressed will be seen in the forward curve for gold.  Over the past week GOFO rates published by the LBMA have all increased indicating fresh supply of gold available on loan, or a reduction in demand to borrow gold.  This has normalised the gold curve out to 12 months.

I read opinion suggesting that this normalisation can’t be trusted because member contributors mis-reported their quotes to avoid highlighting the problem.  I think gold commentators need to avoid calling foul every time the price or other market variable goes against their prediction or desired direction.

Instead by digging a little deeper we can see that this normalisation doesn’t tell us about the rest of the forward curve – beyond 12 months.

As a counterparty to a 5 year lease rate swap agreement with a major bullion bank, I see daily movements in this part of the curve.  Interestingly, even though short dated GOFO has normalised (and therefore short term gold lease rates have fallen) over the past week, the valuation of my lease rate swap agreement (to pay fixed lease rates and receive floating lease rates every 3 months for 5 years) has increased.  This means that over the past week, the market’s view on “average lease rates over the next 5 years” has actually increased – despite the decease in lease rates from 1 month to 12 months.

This means the market’s demand to borrow gold has simply moved further out along the forward curve.  In other words, institutional participants are expecting a tight gold market to persist for years to come, and are taking action to borrow gold now before it’s too late.