*Quoted Directly from This Website. Comments by D. C. Nachman in Brackets

glossary*

Lease Rates

The lease rate is the cost of borrowing gold. In much the same way that individuals borrow dollars, pay an interest charge, and then return dollars to the lendor, gold bullion participants will borrow ozs of gold, pay a borrowing cost, and return ozs of gold to the lendor. The debt is measured in terms of ozs as opposed to dollars. The value of the metal when it is being borrowed or returned is not a factor. [Except that the borrowing cost is a percent, the lease rate, of the spot price of gold.]The central banks are the main lendors of gold and the borrowers are the large industry participants. The lending and borrowing of gold is pretty much reserved for bullion bankers, mining companies, and jewelry manufacturers. You can ask your bank manager to lend you 10 ozs of gold, but you would almost certainly draw a confused look on his face.

There are two factors that determine the going lease rate which is determined by market forces alone. One is the difference in demand between gold for immediate physical delivery (spot) and gold contracts for later delivery (futures). The other being the current interest rates for borrowing $US dollars. [The first factor is measured by the difference between the spot price for gold and the forward price of gold, say. The second factor is the interest rate . Given , , and , the spot/futures parity theorem that , then determines, the cost of borrowing gold, the gold lease rate. The difference is called the forward rate. It is the rate at which you future value the spot price to get the forward price.]

High lease rates will encourage stockpilers of the metal to sell into the spot market even when they wish to maintain their inventory levels. Being guaranteed to buy the same metals back for a lower cost at a future date offers them every possible financial advantage. For this reason exceptionally high lease rates cause the demand for immediate delivery to be satisfied, and therefore never last too long. [High lease rates here are interpreted as implying low forward rates and hence low forward prices, a situation where stockpilers have the incentive to sell spot and buy back forward. More generally this can be interpreted as indicating that backwardation relative to the spot price of gold is very unlikely, and this is proven out in the data. We have contango (backwardation) relative to the spot price if the forward rate is positive (negative). Backwardation would be the extreme case of a (relatively) high lease rate.]

*Quoted directly from this website. Comments by D. C. Nachman in brackets.