London Bullion Market Association (LBMA) gold forward offered rates (GOFO) rates have now been negative for over 7 weeks. While GOFO rates have been negative during a few exceptional periods in the past, this is the first time they have been negative for a prolonged period, indicating tightness in the physical market for gold traded on the LBMA.

Strong demand from Asia and developing countries’ central banks, coupled with reduced supply from gold recycling and diminished mining supply, appear to have substantially tightened the market.

What are GOFO Rates?

Gold forward offered rates are effectively the interest an investor has to pay on gold-collateralized US dollar loans. Under normal circumstances, the GOFO rate is positive, with an investor having to pay interest to borrow US dollars against gold collateral. However, since the beginning of July 2013, the one-month and three-month GOFO rates have turned negative, meaning that an investor with gold is now being paid interest to provide gold as collateral against US dollar loans. It is worth noting that over the past week, gold forward rates have trended back into positive territory as higher lease rates (LIBOR – GOFO) have made it more attractive for central banks to lend gold into the market. Despite this, the gold physical market remains tighter compared to history.

Why Are GOFO Rates Negative?

The most likely reason behind prolonged negative GOFO rates is a gold supply shortage. This appears to be confirmed by the simultaneous upswing in the gold price since July 2013 (Figure 1) and the sharp fall to a six-year low of gold inventories backing Comex gold futures (Figure 2). Since the slump of the gold price in mid-April, Comex gold inventories have fallen by 24%, highlighting the lack of liquidity in the gold forward market at the moment.