Trying to understand "gold lease rate"

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Trying to understand "gold lease rate"

Postby BostonFern » Sat Aug 31, 2013 8:18 pm

I'm reading about gold and one thing pops up is the gold lease rate, which is a new terminology to me. So I look for an explanation and found this link:

It specifically says "The lending and borrowing of gold is pretty much reserved for bullion bankers, mining companies, and jewelry manufacturers. "

I can't understand this and have 2 questions:

1. I would think bullion bankers and jewelry manufacturers want to "buy" gold, not to borrow gold. Why do they want to borrow gold?

2.What does "borrowing gold" really mean? Does it mean gold is delivered to the borrower at a least price while the borrower sign a contract of returning it to the lender at a specific time and at a specific price? How is it different from buying into gold future?

I will appreciate your explanation.

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Re: Trying to understand "gold lease rate"

Postby MooreBonds » Sun Sep 01, 2013 10:32 am

I don't have direct experience or knowledge of this, but I would assume that given how expensive gold is, many jewelers don't want to invest $2MM in inventory in their store by having a variety of gold rings and jewelery paid for with cash.

Since gold is a raw element that is perfectly substitutable, a banker in Zurich who loans out 100 troy ounces to a jeweler in England doesn't care if they get back the same bullion bar or a bullion bar from a mine in South Africa, since the gold is the exact same.

And people who hold gold for assets (central banks, large banks, individuals, mining companies) often aren't in the nature of transacting that gold by buying and selling on a weekly or monthly basis. They're likely holding that gold for a relatively long period of time. Since there is some carrying cost associated with storing and holding physical gold, and since they don't really need access to it in 1 week's time, they can loan it out to a jeweler or someone else for a certain interest rate to help defray the cost of storing it - while still retaining ownership of it for their long-term holding purposes.

The jeweler gets the benefit of being able to make a wide array of jewelery to put in their case to have a lot of different styles on hand, while only paying a relatively low(er) interest rate on all of that inventory without the huge capital outlay and tying up all of that money by paying for the gold with cash.

Kind of a similar thing with diamonds (but not entirely) - a jewelry store isn't likely going to hold a large inventory of diamonds on-hand that they own. They usually ship in a diamond from a diamond wholesaler for a customer to look at, since there are a wide array of diamonds available with different cuts/grades/ratings, and to keep even a small inventory on-hand would require a huge capital investment....and those diamonds may not even be what a random person is looking for.

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Re: Trying to understand "gold lease rate"

Postby BostonFern » Mon Sep 02, 2013 1:50 pm

Thanks for the good explanation.

It seems that this gold lending business not only help the jewelers to defray paying for gold before collecting the money from customers, it also helps them from carrying the market risk of gold. They don't need to worry price of gold goes up and down, as they can pay back the gold lender the same time their customer pay them the market value of gold. They do, however, want to make sure their product is quickly sold, in order to minimize the amount of interest they have to pay to the lender.

What I don't understand is the other explanation offered by the link I posted earlier:

High lease rates will encourage stockpilers of the metal to sell into the spot market even when they wish to maintain their inventory levels. Being guaranteed to buy the same metals back for a lower cost at a future date offers them every possible financial advantage.

I would think high lease rate happens when gold is speculated to go up, or the spot price is lower than the future price. If I have a lot of gold and when I perceive gold price is going up, I would like to hold on to my gold instead of selling them. If I can lend it out to take advantage of high lease rate to make some nice "interest" on my gold, that would be make it even better. What go wrong with my logic here?

A different point, it also seems that any organization with a lot of physical gold can get into this gold lending business, such as GLD or gold miners. It would be a nice side profit if they run it right.

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