ETF Trends
ETF Trends

We continue from last weeks discussion on the role of interest rates in the gold market by looking at trends in the cost of carry of gold as priced in dollars, euro, yen and pounds. By way of a brief primer we define the cost of carry of gold in dollars as the London Bullion Markets Association 3 month Gold Forward Offered Rate (GOFO). GOFO is published every day by the LBMA and is calculated as US dollar Libor minus the gold lease rate.

Gold Forward Offered Rate = USD Libor – Gold Lease Rate

If we think of gold in terms of being a currency, the gold lease rate is the interest rate at which investors can borrow or lend gold. GOFO is then defined as the interest cost of financing a gold purchase (Libor) less the interest rate that can be earned by lending that gold (lease rate). GOFO is calculated daily via market poll by the LBMA and is the market benchmark for gold funding costs. Interestingly in gold markets there is little trading volume in uncollateralized lending or borrowing of gold (gold leases) with by far the most trading volume occuring in the gold swap market (exchanging gold for dollars today and then exchanging those dollars back for gold at an agreed future date) priced at the GOFO interest rate. In these terms another way to describe GOFO would be the cost of borrowing gold with dollars posted as collateral. This also means that in practice the gold lease rate is typically not observed but rather it is implied by subtracting GOFO from Libor. Finally we also define the cost of carry of gold in a non-dollar currency as

2014.8.27_gold chart
Source: Bloomberg LP; Treesdale Partners calculations; past performance is not indicative of future performance

At a high level we see that the cost of carry of gold in all the four currencies has been low and stable over the last two years. Even though there are meaningful differences between the carry costs for each individual gold/currency pair with Gold/Pound having the highest cost of carry and Gold/Yen having the lowest, on their own the carry cost for each pair has largely stayed within a 0.20% range. The low and stable cost of carry has largely been a function of central bank monetary policy with their respective central banks, even in the US and UK which are experiencing stronger GDP growth, indicating that interest rates are likely to stay low for an extended period of time.

Since the start of the year the carry costs of Gold/Dollar, Gold/Yen and Gold/Pound have trended higher with the primary driver of higher carry costs being a rise in GOFO. In contrast Gold/Euro cost of carry has actually trended lower and moved back into negative territory meaning that a US investor would earn a yield to hold gold priced in euro. Of note the move lower in Gold/Euro cost of carry has been driven by a move lower in Eurozone interest rates as the Eurozone struggles with stuttering GDP growth and rapid disinflation and which has more than offset the rise in GOFO. The previous recent low in Gold/Euro cost of carry was in July 2013 when it touched -0.20% but with the fall being a function of lower GOFO rather than lower euro interest rates and where GOFO itself turning negative for short periods of time.

Finally we note that negative GOFO (indicating that investors earn a yield to hold gold priced in dollars) historically is a fairly infrequent occurrence but instances of negative GOFO have typically been symptomatic of “excess demand” for physical gold and often been accompanied by moves higher in the price of gold in dollar terms. Although counterintuitive, in a previous commentary, we discussed why the cost of carry of gold might turn negative and showed that it is typically caused when gold investors are willing to pay a premium (called the “convenience” yield) to hold physical gold rather than gold for future delivery and which in turn might be caused by market conditions that tighten the supply and demand balance for physical gold.

This article was written by Treesdale Partners, portfolio manager of the AdvisorShares Gartman Gold/Euro ETF (GEUR), AdvisorShares Gartman Gold/British Pound ETF (GGBP), AdvisorShares Gartman Gold/Yen ETF (GYEN) and AdvisorShares International Gold ETF (GLDE).