This article appeared on the site of Advisor Perspectives, a group of advisors focused on investment strategy.

We continue from last weeks discussion on the role of interest rates in the gold market by looking at trends in the cost of carry of gold as priced in dollars, euro, yen and pounds. By way of a brief primer we define the cost of carry of gold in dollars as the London Bullion Markets Association 3 month Gold Forward Offered Rate (GOFO). GOFO is published every day by the LBMA and is calculated as US dollar Libor minus the gold lease rate.

Gold Forward Offered Rate = USD Libor – Gold Lease Rate

If we think of gold in terms of being a currency, the gold lease rate is the interest rate at which investors can borrow or lend gold. GOFO is then defined as the interest cost of financing a gold purchase (Libor) less the interest rate that can be earned by lending that gold (lease rate). GOFO is calculated daily via market poll by the LBMA and is the market benchmark for gold funding costs. Interestingly in gold markets there is little trading volume in uncollateralized lending or borrowing of gold (gold leases) with by far the most trading volume occuring in the gold swap market (exchanging gold for dollars today and then exchanging those dollars back for gold at an agreed future date) priced at the GOFO interest rate. In these terms another way to describe GOFO would be the cost of borrowing gold with dollars posted as collateral. This also means that in practice the gold lease rate is typically not observed but rather it is implied by subtracting GOFO from Libor. Finally we also define the cost of carry of gold in a non-dollar currency as:

Gold Currency Cost of Carry = Currency Libor – Gold Lease Rate = GOFO + Currency Libor – USD Libor

gold gofo July 2011 August 2014 category technicals

At a high level we see that the cost of carry of gold in all the four currencies has been low and stable over the last two years. Even though there are meaningful differences between the carry costs for each individual gold/currency pair with Gold/Pound having the highest cost of carry and Gold/Yen having the lowest, on their own the carry cost for each pair has largely stayed within a 0.20% range. The low and stable cost of carry has largely been a function of central bank monetary policy with their respective central banks, even in the US and UK which are experiencing stronger GDP growth, indicating that interest rates are likely to stay low for an extended period of time.

Since the start of the year the carry costs of Gold/Dollar, Gold/Yen and Gold/Pound have trended higher with the primary driver of higher carry costs being a rise in GOFO. In contrast Gold/Euro cost of carry has actually trended lower and moved back into negative territory meaning that a US investor would earn a yield to hold gold priced in euro. Of note the move lower in Gold/Euro cost of carry has been driven by a move lower in Eurozone interest rates as the Eurozone struggles with stuttering GDP growth and rapid disinflation and which has more than offset the rise in GOFO. The previous recent low in Gold/Euro cost of carry was in July 2013 when it touched -0.20% but with the fall being a function of lower GOFO rather than lower euro interest rates and where GOFO itself turning negative for short periods of time.

Finally we note that negative GOFO (indicating that investors earn a yield to hold gold priced in dollars) historically is a fairly infrequent occurrence but instances of negative GOFO have typically been symptomatic of “excess demand” for physical gold and often been accompanied by moves higher in the price of gold in dollar terms. Although counterintuitive, in a previous commentary, we discussed why the cost of carry of gold might turn negative and showed that it is typically caused when gold investors are willing to pay a premium (called the “convenience” yield) to hold physical gold rather than gold for future delivery and which in turn might be caused by market conditions that tighten the supply and demand balance for physical gold.

Written by Ade Odunsi

Submitted by USFunds.com:

Like training for a marathon, investing in gold isn’t for the apathetic or indifferent. It requires strong-willed discipline.

Coming into 2014, gold was in a depressed state. The metal had lost over 28 percent the previous year, its greatest slide since 1980. Investors who dropped out of the race in January no doubt regretted the decision in March after watching the metal unexpectedly soar to above $1,300 an ounce.

And the news didn’t stop there. By midyear, gold was one of the top-performing commodities; last month, India, the world’s second-largest consumer of gold, increased its bullion imports by 65 percent; gold mining stocks are currentlyoutpacing the commodity itself.

When prices plunge as dramatically as they did in 2013 and early 2014, it’s easy—instinctive, almost—for our so-called reptilian brains to hijack our better judgment. Our primordial fight-or-flight response kicks in, and too often we choose to fly, only to regret our decision later.

But we’re stronger than that. Jacqueline Gareau, the 1980 Boston Marathon winner, said of long-distance running: “The body does not want you to do this. As you run, it tells you to stop, but the mind must be strong. You always go too far for your body. You must handle the pain with strategy. It is not age. It is not diet. It is the will to succeed.”

Earlier in the year I spoke with Business Television’s Taylor Theon about this very idea that to invest in gold requires not only discipline but also diversification. As I’ve often stressed, we at U.S. Global Investors recommend that 10 percent of your portfolio should be allocated to gold—5 percent to bullion, 5 percent to mining stocks, and rebalance every year. This should always be the case, whether gold is soaring at a good clip or whether its wings appear to have been clipped.

As I advised Theon’s viewers:

“Be diversified. Just appreciate the seasonality and volatility of all these different asset classes. The DNA of gold over any rolling 12 months is plus or minus 15 percent; gold stocks, plus or minus 35 percent. So any time gold stocks fall 35 percent, it’s become an opportunity to buy. When they fall 60 and 70 percent, it’s a screaming buy. And they will rally, and they will rise.”

And rise they did, just as the theory of mean reversion predicted. Mean reversion, which I discuss at length in Part II of my three-part series on managing expectations, states that security prices will revert to their historic average eventually, whether we’re in a bull or bear market.

Below you can watch the entire interview, during which Theon and I also discuss India and the importance of the Purchasing Managers Index (PMI).

Gold represents a smart hedge in an uncertain global investment climate, Matt McLennan, head of global value at First Eagle, said Wednesday.

“The goal for us is to create an all-weather portfolio,” he said. “And I think what I’d say is that we’re in an environment where risk assets are trading at rather-elevated levels relative to history on the back of very easy policy.”

McLennan oversees $93 billion in assets in the Morningstar four-star-rated First Eagle Global Value Fund.

On CNBC’s “Halftime Report,” he said that his portfolio held 70 percent of its assets in equities, 20 percent in cash and 10 percent in gold and gold miners.

“We live in a world where there’s too much debt and not enough jobs, and that’s leading to financial repression everywhere,” McLennan said. “And in a world of monetary abundance, we’re looking for scarcity, be it in businesses that have hard-to-replicate assets or business models, or in gold itself as nature’s alternative to the man-made financial architecture.”

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Noting that gold tends to perform well “when risk assets are out of favor and vice versa,” McLennan said that it was part of a well-balanced portfolio rather than a stand-alone call on the precious metal.

McLennan said that his portfolio held positions in Gold Corp. and Gold Fields.

“Suffice to say if you think gold is an important part of the ballast of a portfolio, and if you can get it at a discount through the ownership of a gold miner, that makes sense,” he said. “And in the case of Gold Corp., you’re getting a 2 percent-plus dividend yield as well. So, gold at a discount with a yield seems to make sense to us as part of a long-term investment portfolio.”

But beware of the pitfalls before dealing with a buyer at a local shopping centre.

Public Defender tested the market with an 18-carat bracelet.

On a day when gold was trading at $1534 per ounce, we visited five buyers and found a 115 per cent difference, with shopping centre kiosk operator Gold Buyers last.

Gold Buyers at Stockland Merrylands offered us $351 for the bracelet, plus an extra 10 per cent if the sale was finalised that day.

About two years ago Gold Buyers at Westfield Chatswood – which has since closed – offered $140.

We then went to Ian King’s Loan Office, also in Merrylands, which was willing to part with $480, compared with $170 two years ago.

The Gold Company on Castle-reagh St said it couldn’t do better than $700, still much higher than its February 2010 offer of $225.

Next was Grace City Jewellers on York St which promised $720.

Our final visit was to Sydney Gold Traders on George St which weighed the bracelet using sophisticated gold karat analysis technology before offering $805.

The difference from top to bottom was $450 with Sydney Gold Traders leading the way.

Regional manager Jerry Zheng said he offers up to 90 per cent of the spot gold price compared with shopping centre buyers which offer a paltry 30 to 50 per cent.

“Some buyers do business by increasing their profit margin,” Mr Zheng said. “We look for ways to get repeat business.”

Gold Buyers Australia, which offers about 40 per cent of the spot price, did not return calls yesterday.