Gold’s value as a strategic asset has been on the incline in the past few years, as central banks increase their gold holdings. Many central bankers are still unsure about managing their gold holdings due to a lack of transparency in terms of pricing. It doesn’t help that the gold lending market is primarily an over-the-counter (OTC) market, which raises transparency concerns, partly because details about starting price and intra-round prices are not revealed.
That being said, gold lending improves the risk/return profile of central banks. Gold’s lack of correlation to stocks and other major assets helps with portfolio diversification, enabling it to deliver high returns compared to other assets.
It wasn’t always this way. The gold market was mostly bearish from the 80s to 1999, when central banks signed the Central Bank Gold Agreement. Before 1999, gold lending rates there were no definitive tools in place for central bankers to accurately assess their risk profile. This meant that central bankers had lower expectations for gold prices.
The CBGA stabilized the market and provided more transparency in gold lending rates. This allowed the gold market to gain momentum after 1999. As a result, central banks were more inclined to hedge their bets on gold.
Despite the positive trends for GLR, it will remain low (or even negative) in the future for two main reasons:
- Real interest rates are too low (and sometimes negative) which increases the prices of gold, translating into lower GLT
- Mining industries’ hedging demand will stay low (especially if gold prices keep increasing) while lending supply from central banks remain weak
This isn’t to say that central banks shouldn’t lend to improve their returns on gold reserves under favorable conditions. Central banks may be ready to increase lending supply if the following conditions are met:
- Knowing both allocated and unallocated risks
- A solid legal contract that ensures that any gold lent is Good Delivery as defined by the London Bullion Market Association (LBMA)
- Robust finance infrastructure to manage gold lending trades