Gold Derivatives: Gold Derivatives: - World Gold Council

contracts they have with producers. In rolling spot or spot deferred contracts the
price the bank is committed to paying for future production is reduced if lease
rates rise. Furthermore there is considerable use of products such as lease rate swaps
which shifts the risk between banks, and between banks and producers. There is
some evidence also of central banks taking on some of the lease rate risk.
Although producers disclose much more information about their hedge books
than they used to, it is still not possible in most cases to predict how far any
individual producer would be affected by a sudden spike in lease rates, nor indeed
how much of the risk is borne by producers collectively as opposed to commercial
banks. But it is possible to make certain general observations. First, that rare large
price moves have in the past, and are likely in the future, to bring about commercial
failures. Second, that these are more likely to occur among producers than
commercial banks because the commercial banks active in the gold market tend
to be far more heavily diversified than are producers. Third, the risk of large
moves in lease rates reduces the attractiveness of hedging since it brings a new risk
which either the hedger or the seller of the hedging product has to bear, which
would not exist if there were no hedging.
5.2 Scenario 2: A cutback in demand for
borrowing
While much of the discussion about the stability of the lending market has focused
on the possibility of a crisis brought about by a sudden spike in lease rates,
concerns have also been expressed about the possible consequences of a sudden
reduction in demand for borrowing.
5.2.1 A change in producer hedging policy
Suppose that all producers decide to allow their existing hedges to run to maturity,
but not to take out any new hedges. The size of the aggregate producer hedge
book would decline by some 800 tonnes in the first year alone. The banking
sector would have that much less in the way of forward sales to hedge and would
reduce its borrowing of gold by a similar amount.
Lease rates would decline sharply. In the short term lenders of gold are not sensitive to
lease rates so the impact of the reduction in demand would fall directly on the cost of
borrowing. Lease rates are likely to decline to levels where many lenders would not
find it worth while lending at all; this floor level is probably in the region of 0.5%.
The effect on the gold price is not so clear. There is mixed evidence as to whether
the build up in hedging depressed the gold price; a reversal of the build up might
also fail to have a clear impact on the gold price. Against this, it could be argued
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Gold Derivatives: The market impact