What's the deal with gold today?

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The chart looks like it's on a pogo stick.

-- Ron Schwarz (rs@clubvb.com.delete.this), November 09, 1999


Friday is Dec contract expiration date. Shorts would like it as low as possible before then. A battle.

-- goldbug (goldbug@mint.com), November 09, 1999.

Banks Shying Away From Gold Arbitrage

Industry: PCS Subject: DJN DJWI COR DJS GPC PCS Market Sector: BSC NND TPX Product/Service: DMM

By Janet Whitman

NEW YORK ( 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.

Bullion Banks Vulnerable To A Swing In Lease Rates

Since February 1996, when the price of gold peaked at around $417 a troy ounce, until last spring, lease rates rarely rose above 1% 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%, 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% for a two- to three-year period, and then nearby rates spiked up to more than 5%," said one bullion dealer in New York. "That's a lot of money we're talking."

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% 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.

Concerns About Liquidity Crunch Before Y2K

One-month lease rates have returned below 1%, 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."

-By Janet Whitman; Dow Jones Newswires; 201-938-2208; Janet.Whitman@dowjones.com

-- OR (orwelliator@biosys.net), November 09, 1999.

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