krakknisse
06-15-08, 03:17 PM
Out of a purely theoretical interest in monetary metals, I'd like to share some of what I've learned and some sources of information. Some of you may have followed the Eric Janszen's "ITulip hypothesis". There is still every reason to believe that gold will be a good investment. I hope some of this can help in understanding the substantial volatility. The primary source for this is Antal E. Fekete, but I've added some other sources as well. The gist of it is: watch the futures curve. Watch the gold basis. If the basis is sinking (less contango), in line with further deterioration in the trust in fiat money, that is bullish for gold. Permanent backwardation is the wet dream of gold bugs. There is not more here than you can find with some fancy googling, but I hope you appreciate it, anyways. Hope the ITulip police don't get me for extensive out-of-site quotations.
Gold is a commodity that stores indefinitely (at a cost). It does not degrade and is not consumed significantly. This makes the gold commodity market quite different from other commodities markets. The above ground stores are very large compared to the yearly new output. These reasons are exactly why it is the monetary metal par excellence. Most agricultural commodities futures markets are very different - agricultural products don't store well, and are all consumed.
Over at the Kitco forums (https://www.kitcomm.com/forumdisplay.php?f=7), you can read users posting alternating wailing and laughter with the price of gold going up or down. I was hoping to go beyond that. There is significant suspicion over there over "unspecified" manipulation.
You can always start with the sometimes Biblically inclined Antal E. Fekete:
THE RISE AND FALL OF THE GOLD BASIS (http://www.gold-eagle.com/gold_digest_05/fekete062306pv.html)
and
The last contango in Washington (http://www.financialsense.com/editorials/fekete/2006/0604.html)
If a market is in contango (future price higher than spot price), then a producer can effectively lock in a higher gold price today. Take a look at this worked example that I found.
AIG Journal - Applied Geoscientific Research and Practice in Australia
HEDGING AT ITS MOST BASIC (http://www.aig.asn.au/aigjournal/pdf/Hedging%20Basics.pdf) - Ian Levy - Gympie Gold
INTRODUCTION
Do this as a worked example – it saves words.
The gold price has “jumped” to A$500 per ounce and we, the Miner, want to lock this “good” price in for 1,000 ounces to be delivered in exactly 12 months time.
Rates For This Example
Spot price = A$500 per ounce.
Australian 12 month cash interest rate = 7%
12 month gold lease rate (or gold borrowing fee) = 2%
Banker’s profit margin = 0.25% (depends on “credit rating”)
How Hedging Happens
1. Miner (ie. our company) advises its “dealer” counterparty (eg. Rothschild Bank) to sell 1,000 ozs forward for 12 months at this spot price.
Dealer raises 1,000 x 500 = $500,000 cash and promises to repay the gold in 12 months plus the interest rate charged by the central bank on gold, usually called the gold lease rate or more legally, the gold borrowing fee.
3. Dealer’s bank (eg. Rothschild) immediately invests the $500,000 onto the cash interest rate market to earn normal interest minus the lease rate.
Therefore, in 12 months time, Dealer can pay Miner more than the $500,000 for 1,000 ounces of gold because the Dealer:
• Still has the $500,000 it raised on the 1,000 ozs = $500,000
• earns cash interest on the$500,000 of 7% = $ 35,000
• pays the gold borrowing fees of 2% = $ 10,000
• takes a bankers fee of 0.25% = $ 1,250
Net amount payable to Miner = $523,750
So, all Miner needs to do is deliver 1,000 ozs of gold to Dealer in 12 months time to receive
$523,750 – an effective gold price of $523.75 per ounce.The reason this thing works at all is that the market is in contango. If the market were in backwardation, the gold lease rate would be negative and the hedge wouldn't work as profitably. The gold market has in fact been in backwardation during parts the last year. Because of this, the producer can "lock in" the current price and a little of the future price implied by the contango.
Clearly, these are legitimate income-generating strategies from the viewpoint of the producer. They do, however, require a lender of gold - a reserve bank. The reserve banks find it useful to lend out gold, because they get paid for their otherwise pretty inanimate gold stores. They do take a small risk of default.
Now, GATA asserts that unnamed central banks manipulate the market, in part assisting through large loans, in order to "to conceal the mismanagement of the U.S. dollar so that it might retain as the world's reserve currency". This was very publicly expressed by GATA throuough a full-page advertisment in the Wall Street Journal, January 31, 2008.
You can form your own opinion on what the goals of the central banks are, and whether you consider them immoral. But at least you know how they are able to participate in markets with their "dead" reserves.
For me, at least, this learning trip has meant that I will not only follow, purely for theoretical pleasure, the price of gold, but I will also watch the gold basis.
The gold futures curve is not difficult to find. Here is one site (http://www2.barchart.com/dfutpage.asp?sym=GC&code=BSTK) that lists the next 19 months (no chart). But you can also just go to the LBMA price site (http://www.lbma.org.uk/statistics_current.htm)- they will helpfully list the gold futures, LIBOR and lease rate (LIBOR minus futures), which tells you if the market is in contango or backwardation at various time points.
So, for your benefit, here is the gold basis from 1998-2008 (data from LBMA). To me, it seems that though gold is still in contango, levels are quite low. An important event will be if gold turns into backwardation during the next worsening of the current crisis. It is not far away, methinks.
http://i26.tinypic.com/91c743.png
Gold is a commodity that stores indefinitely (at a cost). It does not degrade and is not consumed significantly. This makes the gold commodity market quite different from other commodities markets. The above ground stores are very large compared to the yearly new output. These reasons are exactly why it is the monetary metal par excellence. Most agricultural commodities futures markets are very different - agricultural products don't store well, and are all consumed.
Over at the Kitco forums (https://www.kitcomm.com/forumdisplay.php?f=7), you can read users posting alternating wailing and laughter with the price of gold going up or down. I was hoping to go beyond that. There is significant suspicion over there over "unspecified" manipulation.
You can always start with the sometimes Biblically inclined Antal E. Fekete:
THE RISE AND FALL OF THE GOLD BASIS (http://www.gold-eagle.com/gold_digest_05/fekete062306pv.html)
and
The last contango in Washington (http://www.financialsense.com/editorials/fekete/2006/0604.html)
If a market is in contango (future price higher than spot price), then a producer can effectively lock in a higher gold price today. Take a look at this worked example that I found.
AIG Journal - Applied Geoscientific Research and Practice in Australia
HEDGING AT ITS MOST BASIC (http://www.aig.asn.au/aigjournal/pdf/Hedging%20Basics.pdf) - Ian Levy - Gympie Gold
INTRODUCTION
Do this as a worked example – it saves words.
The gold price has “jumped” to A$500 per ounce and we, the Miner, want to lock this “good” price in for 1,000 ounces to be delivered in exactly 12 months time.
Rates For This Example
Spot price = A$500 per ounce.
Australian 12 month cash interest rate = 7%
12 month gold lease rate (or gold borrowing fee) = 2%
Banker’s profit margin = 0.25% (depends on “credit rating”)
How Hedging Happens
1. Miner (ie. our company) advises its “dealer” counterparty (eg. Rothschild Bank) to sell 1,000 ozs forward for 12 months at this spot price.
Dealer raises 1,000 x 500 = $500,000 cash and promises to repay the gold in 12 months plus the interest rate charged by the central bank on gold, usually called the gold lease rate or more legally, the gold borrowing fee.
3. Dealer’s bank (eg. Rothschild) immediately invests the $500,000 onto the cash interest rate market to earn normal interest minus the lease rate.
Therefore, in 12 months time, Dealer can pay Miner more than the $500,000 for 1,000 ounces of gold because the Dealer:
• Still has the $500,000 it raised on the 1,000 ozs = $500,000
• earns cash interest on the$500,000 of 7% = $ 35,000
• pays the gold borrowing fees of 2% = $ 10,000
• takes a bankers fee of 0.25% = $ 1,250
Net amount payable to Miner = $523,750
So, all Miner needs to do is deliver 1,000 ozs of gold to Dealer in 12 months time to receive
$523,750 – an effective gold price of $523.75 per ounce.The reason this thing works at all is that the market is in contango. If the market were in backwardation, the gold lease rate would be negative and the hedge wouldn't work as profitably. The gold market has in fact been in backwardation during parts the last year. Because of this, the producer can "lock in" the current price and a little of the future price implied by the contango.
Clearly, these are legitimate income-generating strategies from the viewpoint of the producer. They do, however, require a lender of gold - a reserve bank. The reserve banks find it useful to lend out gold, because they get paid for their otherwise pretty inanimate gold stores. They do take a small risk of default.
Now, GATA asserts that unnamed central banks manipulate the market, in part assisting through large loans, in order to "to conceal the mismanagement of the U.S. dollar so that it might retain as the world's reserve currency". This was very publicly expressed by GATA throuough a full-page advertisment in the Wall Street Journal, January 31, 2008.
You can form your own opinion on what the goals of the central banks are, and whether you consider them immoral. But at least you know how they are able to participate in markets with their "dead" reserves.
For me, at least, this learning trip has meant that I will not only follow, purely for theoretical pleasure, the price of gold, but I will also watch the gold basis.
The gold futures curve is not difficult to find. Here is one site (http://www2.barchart.com/dfutpage.asp?sym=GC&code=BSTK) that lists the next 19 months (no chart). But you can also just go to the LBMA price site (http://www.lbma.org.uk/statistics_current.htm)- they will helpfully list the gold futures, LIBOR and lease rate (LIBOR minus futures), which tells you if the market is in contango or backwardation at various time points.
So, for your benefit, here is the gold basis from 1998-2008 (data from LBMA). To me, it seems that though gold is still in contango, levels are quite low. An important event will be if gold turns into backwardation during the next worsening of the current crisis. It is not far away, methinks.
http://i26.tinypic.com/91c743.png