Issue 6
Transparency in Gold Lease Rates
Before 1989, the gold forward market was, to quote Winston Churchill "a riddle shrouded in mystery wrapped up in an enigma". Transparency was non-existent and price levels could only be ascertained by direct contact with market practitioners. The LBMA took the first step towards improving this situation in July 1989, with the development and introduction of the Gold Forward (GOFO) page on Reuters. Now, GOFO - which shows gold swap rates - will be joined by LGLR, which will provide market participants with an indicative benchmark for gold lease mid-rates.
History
GOFO was originally inspired by a request to the Market-Making Members of the LBMA by N M Rothschild & Sons Ltd., who saw a commercial advantage in providing a 'Forward Rate Agreement service in gold interest rates to their clients. At that time, a new word was incorporated into the language of gold traders, though the Oxford English Dictionary has yet to give due recognition to "GOLDFRA". This is a simple forward rate agreement which determines the interest rate that will apply to a notional future loan or deposit of an agreed amount of gold for a single interest period of up to one year. Other traders soon saw the possibilities afforded by the daily gold interest rate benchmarks and responded positively to a concept which allowed the market to create more specialised, tailor-made structures for clients.
How the GOFO benchmark is calculated
A1though most readers are probably already familiar with GOFO, the following is a quick review. The GOFP and GOFQ pages on Reuters show the rates - expressed in US$ interest rates - at which the contributors are prepared to give gold and take dollars on a swap basis; the quotes are for one, two, three, six and 12 months respectively. In order to be accepted as a contributor, an institution must be a Market-Making Member of the LBMA.
These pages feed through to a "headline" page on GOFO which indicates the most recent updates. At 11.00am London time each day, the mean rate is calculated for each period by taking the average of all the contributors' quotes after discarding the highest and the lowest quote for each period.
The new LGLR page
This page will show the effective mid-rate for gold leases for all periods currently quoted on GOFO. Generally speaking, gold swaps are quoted in the market with a bid/ offer spread of approximately 25 basis points. Furthermore, when a gold lease is calculated, then the spread on the currency deposit component must also be taken into account; this has been taken as 12.5 basis points. Therefore, under normal conditions, a mid-rate for gold leases can be calculated by reference to the following formula: US$ LIBOR - (GOFO + 19 bp) Gold lease mid-rate.
Should extreme market conditions prevail a committee comprising three experienced market professionals has been established order to calculate a best estimate of the true mid-rate during such periods of high volatility.
We must emphasise that this published mid-rate is purely for indication and should not be taken as the basis for any business. Most importantly, credit considerations are not taken into account.
The greatest long-term benefit of the new page should be to provide a service which will assist accountants and auditors in marking to market outstanding forward and options positions. Chartists will also find the mid-rates a useful tool for taking historical data.
The Management Committee of the LBMA is pleased to have taken this initiative to create Further transparency in the market and feels sure that publication of these rates will be of benefit to the whole spectrum of market participants.
The new LGLR page
This page will show the effective mid-rate for gold leases for all periods currently quoted on GOFO. Generally speaking, gold swaps are quoted in the market with a bid/ offer spread of approximately 25 basis points. Furthermore, when a gold lease is calculated, then the spread on the currency deposit component must also be taken into account; this has been taken as 12.5 basis points. Therefore, under normal conditions, a mid-rate for gold leases can be calculated by reference to the following formula: US$ LIBOR - (GOFO + 19 bp) Gold lease mid-rate.
Should extreme market conditions prevail a committee comprising three experienced market professionals has been established order to calculate a best estimate of the true mid-rate during such periods of high volatility.
We must emphasise that this published mid-rate is purely for indication and should not be taken as the basis for any business. Most importantly, credit considerations are not taken into account.
The greatest long-term benefit of the new page should be to provide a service which will assist accountants and auditors in marking to market outstanding forward and options positions. Chartists will also find the mid-rates a useful tool for taking historical data.
The Management Committee of the LBMA is pleased to have taken this initiative to create Further transparency in the market and feels sure that publication of these rates will be of benefit to the whole spectrum of market participants.