There are a few misconceptions when it comes to the gold lending market and central banks’ role in it. This is because the gold lending markets are over-the-counter (OTC) markets where transactions between two parties are direct and a broker or central exchange entity is not present to oversee the deals made. Therefore, the process of gold leasing is generally obscure.
In the article, we will clearly explain all you need to know about the gold lending market and how central banks around the world facilitate this process.
Gold Leasing or Gold Lending
To explain simply, gold leasing or gold lending is when one party rents out its gold reserves to another party on a contract basis. Now you might wonder why anyone needs to do that. The gold industry works relies on lending rather than buying, as this helps them to maintain working capital to pay off their debts and immediate expenses (salaries, utility bills etc.).
Let’s take the example of gold mining companies that are unable to meet their monthly production demands. To meet their expenses, they lease refined gold from central banks and sell it. Once the company is able to excavate the required volume of gold, they either sell the refined product to the very bank that they leased it from or may choose to sell it to other buyers and pay the bank the money it owes them, depending on the current gold lease rate (GLR).
Gold Lease Rate
Recently, the World Gold Council published a Guidance Paper on Gold Deposit Rates that acts as a comprehensive guide for central bank managers to value gold as an asset and to help them increase their gold holdings through appropriate purchases of gold reserves. It is important to understand that banks do not control gold prices nor is the GLR same as the interest rate.
The GLR is the cost of borrowing gold from bullion or central banks and is derived as the difference of LIBOR and GOFO (e.g. if the LIBOR is 4% and GOFO is 1%, the GLR will be 3%). So, even though the price of gold is affected by the interest rate, the GLR mostly remains low at an average of 5%.
In recent years, gold miners hedging demands have decreased and they are borrowing less money from the banks which has further reduced the GLR as banks are now buying more gold as compared to selling it. In the future, investment managers forecast that with the interest rates dropping significantly, GLRs may even become negative and this could further demotivate banks to lease gold.
However, the gold lending market could see rapid growth especially when the economy recovers, and the gold price reduces because this will encourage gold miners to sell their gold reserves. In such conditions, the central banks will respond by lending their gold at significantly higher GLRs to earn higher profits on their leased gold reserves.