The dynamics of the forward curve for gold is quite different to other commodities. Because gold is relatively easily stored and there is a large stock of gold that can be lent out via bullion banks and central banks, the cost of carry is almost always function of the arbitrage into money markets.
This means that gold prices have for the vast majority of the time been in contango, or forward prices are higher than today.
But it currently appears to be one of those periods outside of the "almost always", with GOFO (gold forwards) slightly negative when expressed as percentages.
This happened once before in recent history in 2008, although only at the 1 month duration. This time around, however, GOFO is negative all the way out to 6 months.
The dynamics of negative GOFO is also quite unusual. Back in 2008, it was driven by gold lease rates failing to fall as fast as LIBOR rates as central banks came to the rescue during the crisis. This time around, LIBOR has been very steady, while gold lease rates have been climbing to the highest levels since 2009.
So what does this mean? In a nutshell, it suggests there has been a big shift in the cost of borrowing gold (in London Good Delivery form) vs. the cost of borrowing money.
What could be happening is that the crash in prices in recent months has created physical demand that cannot be met by stock sitting outside of bullion banks. Anecdotal evidence suggest the demand pull from China is very strong, with premiums in Shanghai over London soaring in the last few months.
Of course not all the parts of the physical equation are strong, with the sell down in ETFs still intense. Negative GOFO while there is such a large, visible sell down in ETFs suggests that physical demand elsewhere is providing a significant offset.
An alternate and more radical interpretation is that perhaps the gold market is telling us something money markets are not. It seems unlikely that the real cost of short term USD is currently much different to LIBOR rates. But we have certainly seen spiky interbank rates in China at the moment.
Perhaps money markets in China are playing a more important role in setting gold forwards than in the past, which would be a monumental shift in the way gold markets behave.
Either way, this is a strong signal that physical demand for gold has tightened up dramatically even with the huge ongoing sell down in ETFs. But is that enough to be bullish on flat prices? I think its a tough sell, especially in an environment of a rising USD and falling Treasury prices.
