Gold Derivatives: Gold Derivatives: - World Gold Council

The existence of the lending market allows owners of gold to get extra income
from their holdings by lending it. Derivatives also greatly widen the range of
strategies available, particular to large holders, for managing their gold holdings.
Through lease rate swaps they can get access to higher lending rates; through
writing calls on their gold they can earn premium, though of course at the cost of
giving up some of the upside potential. In general, by increasing the flexibility of
managing gold reserves, and increasing the return from holding gold, derivatives
make gold a more attractive asset to hold.
The ability to borrow gold easily and at low rates is of benefit to all those involved
in downstream activities such as refiners, fabricators and distributors. It reduces
the costs of manufacturing and selling gold products. By reducing the costs and
risks associated with holding stocks, it allows very large inventories of gold and
low value-added jewellery to be held in the supply chain. This encourages the
widespread distribution and availability of gold and thus facilitates the marketing
of gold to customers.
Derivatives also reduce the cost of capital for producers, and so tend to encourage
production. A producer may be unwilling to develop a mine which is only marginally
economic for fear that the gold price will fall and make the mine unprofitable.
Using derivatives, the producer can lock in a price, or put a floor on the
price so as to insulate the mine from price falls. Project finance for new mines is
often conditional on output being sold forward.
Derivatives may also affect decisions about existing capacity. The Cross Report
has evidence that producers who have sold their production forward may be slower
to cut production as spot prices fall.
This suggests that while the direct impact of accelerated supply from short selling
are likely to have depressed the price somewhat, the indirect effects of the derivatives
market through expanding both the demand and the supply side of the
market have had an ambiguous effect on the price.
Gold Derivatives: The market impact 61