Gold - Prepare for Lift Off

Many gold bugs have been asking why gold has not soared in the face of the global financial crisis. After all, shouldn't it be a given that inflation will soar as governments print their way out of this crisis? Is not the yellow metal a haven of safety should the world go mad and currencies lose all value? The answer is that it is but short term issues are at play here.

Central banks lease physical gold out at around 3 to 4% for 1 month or 3 months at a time. They make a risk free profit on this and they get their gold back at the end. Many banks are still short of 1 and 3 month USD funding so they lease gold from central banks and sell it on the spot market thus holding the spot price of gold down. It's a cheaper way of raising USD funding when you consider that interbank lending rates have gone well above 5%.

The banks that are selling the physical gold on the spot market clearly don't want to be exposed to the gold price moving against them while they have the gold out on loan. So they buy up the future to hedge themselves. Look at the gold forward curve and notice how steep the contango is i.e. futures prices are much higher than spot prices.

While all this is going on everyone around the world is stockpiling their own physical gold and gold miners are facing production problems due to power shortages etc. Many banks are also talking of stockpiling their own physical gold reserves. Once interbank lending rates come back in line (assuming they do at some point) then I would expect to see a classic 'short squeeze' as the banks buy back the physical gold from the spot market in order to return it to the central banks of the world. Certainly the forward curve will flatten out as the spot price rallies and futures are unwound.

Gold will have its day of reckoning and it's getting closer.