THE LONDON BULLION MARKET ASSOCIATION The Effect of Lease Rates on Precious Metals Markets By Merlin Marr-Johnson, Metals Analyst, HSBC Bank USA In the precious metals First, it is probably worth Gold the interest rate differential returning to the simplest Again, the key to lease rates is in between dollar yields and lease markets, lease rates are fundamental of all. As changes in the supply and demand of lending. rates.The producers therefore buying (demand) and selling Staying with gold, the supply side unwittingly reinforced the frequently cited as root (supply) affect prices, so changes for gold lease rates rests firmly on arguments for a declining spot in borrowing (demand) and the large lending reserves market and a rising lease rate. causes for metal price lending (supply) affect lease rates. available to the market. Central The borrowing, of course, banks currently hold helped generate a strong demand behaviour. However, the A lease rate is simply the going approximately 29,000 tonnes of environment for borrowed market ‘price’ for borrowing or gold (multi-lateral institutions gold, which elevated lease rates reason for the lease rate lending the market. If a market is hold around another 4,200 to over 2%. oversupplied relative to demand, tonnes).With the perceived behaviour itself is rarely prices/lease rates are low, and if a economic stability of the 1990s, The reason for the shift lower in market is undersupplied relative and strong returns being achieved lease rates since 2000 stems from examined. This short to demand, prices/lease rates are by most asset classes, central bank an almost total reversal of every high. reserve managers came under factor cited in the previous article aims to discuss increasing pressure to make assets paragraph, causing a marked It is interesting to note, however, work for them. Accordingly, reduction in borrowing demand, the main features of the that an oversupplied spot market central banks entered the market thereby leading to oversupply in does not necessarily mean that the as significant lenders of their the lending market.The vicious leasing markets that lie lending market is oversupplied strategic gold reserves. cycle of price depreciation, strong (nor vice versa). Remember that dollar yields and producer and behind gold, silver, during the late 1990s, when gold It is ironic that the dollar strength fund short selling has been prices were declining from and strong equity market transformed into a positive spiral platinum and palladium. $400/oz in early 1996 to performances drove some central of price appreciation and $255/oz by mid-1999, the spot banks to sell gold to avoid an producer and fund buying. Lease market was awash with gold – but opportunity cost, and that this rates have dropped. lease rates were higher then than very same negative sentiment they are now.As the chart below towards gold as an asset led to In March 2001 a brief surge in shows, one-year lease rates are producers hedging (borrowing the shorter-dated lease rates currently under 1%, but for the gold). Hedging was encouraged occurred as lending was spread four years running from 1996 to by a negative view on gold, and further along the curve – up to an the end of 1999, one-year lease strong interest rates on dollars unprecedented three years by rates averaged 2.12%. that meant producers could sell central banks.The move was in gold forward and borrow it for direct response to a lack of return the interim, taking advantage of in the shorter-dated contracts, 1 Gold Lease Rates 2 Gold Price/Market Positions USD/oz % 6 moz 10 410 5 8 6 390 4 4 370 3 2 350 0 2 330 -2 310 1 -4 290 -6 0 -8 270 -10 250 Jan Jan Jan Jan Dec Dec Dec Dec Dec Dec Jul-02 Jul-99 Jan-94 Jan-97 Jun-00 Jun-94 Jun-97 Apr-01 Feb-02 Apr-95 Feb-96 Apr-98 Feb-99 Mar-93 Sep-01 Sep-95 Sep-98 Dec-99 Nov-00 Aug-93 Nov-94 Aug-96 Nov-97 93 94 95 96 96 97 98 99 00 01 1 month 1 year "'Non-commercials' total net long position – LHS" Gold price - RHS Legend entry page 20 ALCHEMIST ISSUE TWENTY-NINE 3 Platinum Inventory/Price 25 15 5 -5 -15 -25 -35 -45 1975 77 79 81 83 85 87 89 91 93 95 97 99 2001 03 but, as it happened, it market. One-month lease rates Cumulative stock change Platinum price (USD/oz) unfortunately coincided with have averaged 9% over the past some short-term borrowing, two years. and the change in lending patterns caused a short-lived The other key difference 4 Gold Inventory/Price spike in lease rates. Overall, between platinum and gold Inventory, '000t USD/oz central banks have been is the role that the Tokyo 35 700 powerless to stimulate Commodities Exchange 30 600 borrowing demand and, given (TOCOM) plays in the market. 25 500 the current fundamental The volume of material traded 20 400 weaknesses plaguing the major in Japan means that the economies globally, we question platinum lease rate takes a 15 300 whether there is likely to be leading role in driving spot 10 200 committed short selling in gold prices. 5 100 in the years to come. Lease 0 0 rates are likely to remain low. Platinum on TOCOM is a based 1975 1980 1985 1990 1995 2000 on a futures contract – the Platinum active trading month is 12 Cumulative stock change LHS Gold price (USD/oz) RHS The platinum market is the months ahead.This gives the polar opposite to gold, but the public a chance to trade out of 5 Platinum Lease Rates/Price principles remain the same.The the position profitably at some main problem facing both the stage in the ensuing 11 months. % USD/oz spot and the futures markets is If the Japanese general public 30 650 the depletion of above-ground (JGP) sell futures, this position 25 stocks and the lack of a lender will be offset against trade 600 of last resort. Charts 3 and 4, at house long positions, and these 20 550 right, illustrate the point clearly. trade houses will sell spot loco 15 For gold, calculated cumulative Zurich to mitigate the 12- 500 above-ground stocks have barely month risk. In other words, JGP 10 changed over the past 30 years, take an outright position in the 450 5 staying around 32,000 tonnes, market (short in this case) and but the platinum inventory the trade houses are therefore 0 400 levels swing between zero and long futures and short spot, and Dec-00 Mar-01 Jun-01 Sep-01 Dec-01 Mar-02 Jun-02 Sep-02 30 tonnes. Although the they have to finance the 11- Platnium Price, USD/oz (RHS) quantity of inventory held prior month gap. 12 Month to 1975 in platinum is 3 Month unknown, we believe that Trade houses borrow material current inventory levels are on a rolling basis to meet the 6 Palladium Lease Rates/Price close to zero. short obligations, until the contract expires and the trade % USD/oz What is more alarming is that houses receive platinum from 30 with current demand projection the public. All very simple, but 1050 the market is forecast to enter the net outcome is heavy 25 850 uncharted territory with regard borrowing of platinum when 20 to supply and demand deficits. the JGP are short, and 15 Price risks remain skewed to the conversely lending when the 650 upside and there does not JGP are long. Platinum lease 10 appear to be much prospect of a rates are, unsurprisingly, 450 5 net inventory accumulation at volatile.The three clearly visible any stage in the next few years lease rate spikes over the past 0 250 coming in to ease the borrowing two years are associated with: Dec-00 Mar-01 Jun-01 Sep-01 Dec-01 Mar-02 Jun-02 Sep-02 Palladium Price, USD/oz (RHS) 12 Month 3 Month page 21 THE LONDON BULLION MARKET ASSOCIATION 7 Silver Lease Rates/Price 8 Silver Price/Market Positions % USc/oz Moz short covering, lease rate high, moderate price gains USD/oz 20 520 400 7.5 350 7.0 500 300 15 6.5 250 480 200 6.0 10 460 150 5.5 100 440 5.0 50 5 4.5 420 0 -50 4.0 0 400 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Dec-00 Mar-01 Jun-01 Sep-01 Dec-01 Mar-02 Jun-02 Sep-02 Non-commercial net long position - LHS Silver price - RHS Silver Price, USD/oz (RHS) 12 Month 3 Month 1) the palladium price high in Palladium Silver early 2002 Moving to palladium, we believe Finally, a few words on silver. 2) short-covering in post 9/11 that one can now safely classify Silver lease rates are low (one 3) JGP TOCOM short-selling palladium as a by-product metal. month 0.35%, one year 0.7%) coincident with loco Zurich Barring the Stillwater mine reflecting low borrowing demand tightness (in chronological order). (which is, incidentally committed and sufficient lending supply. to expansion), palladium supplies As at the end of 2001 GFMS had Not only can TOCOM positions are dictated by nickel/copper identified 18,440 tonnes of above change very rapidly, the volumes production rates in Russia and ground silver stocks, with 9,200 are large relative to other natural platinum production rates in tonnes held by European dealers borrowers of platinum.