11:40p EST Monday, November 8, 1999
Dear Friend of GATA and Gold:
The following story, distributed today by Dow Jones
Newswires, suggests that the bullion banks have been
burned by the gold-carry trade and aren't eager to get
back into it. It may be a straw in the winds of change.
Please post this as seems useful.
CHRIS POWELL, Secretary
Gold Anti-Trust Action Committee Inc.
* * *
BULLION BANKS RETREAT
FROM GOLD ARBITRAGE
By Janet Whitman
NEW YORK, Nov. 8 (Dow Jones) -- Bullion banks aren't
taking advantage of a time-tested arbitrage opportunity
-- evidence that they got burned by the gold market's
recent volatility, according to some analysts and
bullion dealers.
Bullion banks, those actively involved in trading gold,
lease gold from central banks and private sources at
cheap interest rates. Those banks, like most investment
houses, typically borrow short and lend long, profiting
from the spread. The steep positive yield curve of late
for gold lease rates, which reflects the cost of
borrowing gold, would make this type of trade
particularly profitable.
But bullion banks aren't biting.
The reason, analysts and traders say, is that many of
the banks have been stung by the violent swing in gold
lease rates over the past several months, prompting
orders from senior management to reduce their risk.
"It's a mystery why the bullion banks aren't performing
their normal arbitrage function," said John Brimelow,
director of international equities with with Donald &
Co. Securities Inc. in New York. "I think they're in a
state of paralysis."
The volatility in the gold-lending market already is
said by bullion dealers and analysts to have cost many
banks tens of millions of dollars, and a few banks
hundreds of millions. Large losses, and the potential
for further hits given the uncertainty about the
direction of lease rates and the price of gold, are
keeping bullion banks on the sidelines, traders and
analysts said.
"They got burned and traders, or rather their senior
management, have a very low appetite for doing this
kind of thing," said Jeffrey Christian, managing
director of CPM Group, a New York-based metals
consultancy firm.
Since February 1996, when the price of gold peaked at
around $417 a troy ounce, until last spring, lease
rates rarely rose above 1 percent for a nearby lending
period, making the arbitrage a safe, cheap, and winning
bet for banks.
By August, however, one-month rates shot above 4
percent, reflecting increased hedging activity by gold
mines and fears of a jump in demand for physical gold
ahead of Y2K.
In some cases bullion banks "were lending for 2 to 3
percent for a two- to three-year period, and then
nearby rates spiked up to more than 5 percent," said
one bullion dealer in New York. "That's a lot of money
we're talking about."
The liquidity crunch escalated following news in late
September that 15 European central banks intended to
limit their gold sales and gold lending over the next
five years. After that announcement, one-month lease
rates spiked above 10 percent as market participants
clamored to find supply to cover their massive short
positions -- or bets that prices would fall. Spot gold,
which had been languishing at 20-year lows of around
$255 for much of the summer, leapt to a high of $337.50
an ounce.
While many gold mines and speculative players got
caught by the surprise run-up in the price of gold,
it's the bullion banks that have been worst hit,
traders and analysts said. The relentless slide in gold
over the past three years made them cavalier in their
lending practices, according to some market observers
and participants.
"They were taking a view on rates and not covering
elsewhere," said one risk management specialist.
One-month lease rates have returned below 1 percent,
with the price spike in late September and early
October actually helping to improve liquidity as gold
mines were forced to unwind some of their hedges.
Two-month and six-month rates, however, remain at a
wide spread to one-month rates, which would typically
attract lending by bullion banks.
"It's a very peculiar curve," said Brimelow at Donald &
Co. "In theory, you can borrow one month and lend for
two at 180 basis points higher. That's a tremendous
spread."
Paul Walker, director with U.K.-based research firm
Gold Fields Mineral Services, attributes the strong
positive slope of the yield curve to "typical year-end
book-squaring," exacerbated by Y2K concerns. "Further
out there's a certain nervousness about what the future
holds, especially at the turn of the year," he said.
While volatility in the leasing market is expected to
ease in the new year, some analysts and traders
cautioned that there's still a risk of fireworks
between now and then if liquidity fears escalate.
"Things could still blow," said the hedging specialist,
noting that the amount of leased gold is far in excess
of the physical supply available. Some market
participants fear central banks may start demanding
their gold back ahead of Y2K, and the supply won't be
there, he added. "There's loads of paper out there, but
the gold backing it up (isn't) there."
Other market participants believe the worst is over.
What most agree on is that the heyday in the gold
leasing market is over.
"It's a changed scenario in which the bullion banks are
operating now," said CPM Group's Christian. "I don't
know if anybody is going to go back to the cowboy
trades that they were making six to eight months ago.
Bullion banks were making outright speculative
positions. I think we've seen the end of that."
-END-
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