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A stirring in the long-suffering gold market

Jonathan Fuerbringer
The New York Times
Sunday, March 11, 2001

A tremor is rumbling through the gold market.

The interest rate for lending gold, which generally
hovers around 1 percent, was above 2 percent for 10
trading days and then surged over 6 percent on Friday.

What does this seismic change mean? Is it temporary,
like some past spikes? Or will it persist? If it does,
it would mean higher gold prices ahead.

Higher prices are what the gold market needs. With a
jump of $5.40 on Friday after the surge in lease rates,
gold for April delivery was at $271.50 an ounce. But
gold prices are still down 0.8 percent for the year and
just $17.80 above their 20-year low.

A rally would help gold stocks, which are already among
the stock market's best performers this year. Investors
betting on such a rally often buy gold-company stocks
instead of the metal because stocks get a bigger lift
when the price of gold rises.

The lease rate is the charge for lending gold to
producers, who sell gold to lock in prices for future
production, and to investors, who sell gold to go
short, hoping to make a profit if the price falls. The
lease rate is normally very low because the world's
central banks have a lot to lend.

For years, gold producers and short-sellers have taken
advantage of low lease rates. And because the borrowed
gold was sold to hedge or to bet against gold, lending
added to the downward pressure on gold prices.

So a high lease rate can shift market dynamics. The
higher cost discourages short- sellers from betting
against gold. Many of them, in fact, buy gold to unwind
short positions and, in doing so, push gold prices
higher, as happened last week. The higher cost also
deters producers from hedging.

But determining if the jump in lease rates is temporary
or permanent is difficult. First, this surge has no
certain explanation. Second, it is hard to judge
probable causes in a market so divided between
believers in the "magical" qualities of gold and those
who dare to treat it as a mere commodity.

The increase in the lease rate would be clearly
significant if it could be traced to a decision by one
or more European central banks to curtail their gold
lending. The World Gold Council, which represents major
gold producers, has been lobbying central banks to do
just that.

But while many analysts can say confidently that
central banks are unhappy with low leasing rates, they
cannot say that a central bank has changed policy.

One possibility, however, is that the Bank of England
has reduced its lending. That might not be a bad
tactic, given that the bank will auction 25 tons of
gold on Wednesday as part of its planned sale of 415
tons over three years. If lease rates hold and the
price of gold rises, the bank could do better than
expected a few weeks ago.

It would make sense for central banks to curtail their
lending as a way to support the price of gold, which
many of them are selling. The problem is that in recent
years, any jump in lease rates has attracted other
lenders into the market, pushing the rates back down.
So while the price of gold has risen with increases in
lease rates, it has also fallen quickly as lease rates
declined.

The last big lease-rate surge came in the summer and
fall of 1999, after gold hit what was then 20-year low
of $253.70 an ounce.

By September, the one-month lease rate was more than 4
percent at an annual rate. Then, on Sept. 26, European
central banks announced that they would limit their
annual gold sales in the next five years to 400 tons
and restrict the amount of gold that they would lend to
then-current levels.

That sent the lease rate to 9.9 percent. From Sept. 20
to Oct. 6, the gold price jumped almost 30 percent, to
$326 an ounce. But by November, the lease rate was back
below 1 percent and the price was less than $300.

Even if the current lease-rate jump does not last, it
should produce a nice pop in gold. And though it may be
brief, that is about as good as it gets in the gold
market today.