As a highly liquid asset with pro- and countercyclical properties, gold is widely recognised as a store of value. As such, it can help central banks meet their core objectives of safety, liquidity and return. Nonetheless, there is one pervasive concern about gold as an investment asset: that it does not offer any yield.
This is a misconception. Among central banks, gold can be actively managed to generate additional returns, in two key ways. They can lend out their gold reserves and earn the gold deposit rate.1 They can also swap their gold for dollars at the gold offered forward rate (GOFO) or swap rate.
Looking back over recent decades, there have been three distinct periods in gold lease rates that can be characterised by progressively lower mean and volatility. Between 1989 and 1999, the gold deposit rate offered a decent source of return for central banks, with the 12-month gold lease rate averaging 1.4%.2 Since that time however, the rate has fallen sharply, averaging just 0.54% between 2000 and 2009 and 0.24% between 2010 and 2019.
This decline has prompted widespread interest, with attention focused on three key questions:
- Why has the gold lease rate fallen?
- Will it ever increase?
- What are the factors that influence its performance?
In this paper, we seek to answer those questions by assessing how gold lease rates have been affected in the past through changes in the demand to borrow gold and the supply of gold available for lending. We then compiled a list of potential drivers and tested their impact on both the 3-month and 12-month gold lease rates. We found that, while gold lease rates often take random and unpredictable paths in normal times,3 certain key drivers have been instrumental in explaining the causes behind gold lease rates’ decline in recent years. These drivers also explain the spikes that have been observed in gold lease rates and allow us to determine that, if similar market conditions were to manifest again in the future, similar reactions in gold lease rates could be expected.4 With prediction accuracy of 62% and 74% for the 3-month and 12-month gold lease rates respectively,5 our model shows that, in decreasing order of importance, these factors are:
- Real interest rates6
- Gold holdings of central banks that are signatories to the Central Bank Gold Agreement (CBGA)
- Gold producers’ hedging demand
- The real price of gold
- Equity market volatility7
- Speculative positioning in gold.8
Broadly, improving gold price sentiment, a decline in the opportunity cost of holding gold and a reduction in central bank sales have prompted a fall in producer hedging demand and made the gold carry trade and speculative short-selling less attractive. As a result, borrowing demand has fallen and gold lease rates have declined. At certain times, however, one-off crises created a rush for US dollar liquidity, which contributed to spikes in gold lease rates, as banks and corporations sought to use borrowed gold to raise US dollars.