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186

GOLD FUTURES

COMMODITY FORWARDS AND FUTURES

is constructed using more expiration dates than are in Figure 6.2.) What is interesting
about the gold forward curve is how relatively uninteresting it is, with the forward price
steadily increasing with time to maturity.
From our previous discussion, the forward price implies a lease rate. Short-sales
and loans of gold are common in the gold market, and gold borrowers in fact have to pay
the lease rate. On the lending side, large gold holders (including some central banks) put
gold on deposit with brokers, in order that it may be loaned to short-sellers. The gold
lenders earn the lease rate.
The lease rate for gold, silver, and other commodities is computed in practice using
equation (6.12) and is reported routinely by financial reporting services. Table 6.9 shows
the 6-month and I-year lease rates for the four gold forward curves depicted in Figure
6.3, computed using equation (6.12);

Example 6.2 Here are the details of computing the 6-month lease rate for June
6, 2001. Gold futures prices are in Table 6.9. The June and September
futures prices on this date were 96.09 and 96.13. Thus, 3-month LIBOR from June
to September was (100 - 96.09)/400 x 91/90 = 0.988%, and from September to
December was (100 - 94.56)/400 x 91/90 = 0.978%. The June to December interest
rate was therefore (1.00988) x (1.00978) - 1 = 1.9763%, or 1.0197362 annualized.
Using equation (6.12), the annualized 6-month lease rate is therefore
1.0197632
)
6-month lease rate = ( (269/265.7)(1/0.5) - 1 = 1.456%

Six-month and 12-month gold lease rates for four

dates, computed using equation (6.12). Interest rates
are computed from Eurodollar futures prices.

187

Gold Investments
If you wish to hold gold as part of an investment portfolio, you can do so by holding
physical gold or synthetic gold-i.e., holding T-bills and going long gold futures. Which
should you do? If you hold physical gold without lending it, and if the lease rate is
positive, you forgo the lease rate. You also bear storage costs. With synthetic gold,
on the other hand, you have a counterparty who may fail to pay so there is credit risk.
Ignoring credit risk, however, synthetic gold is generally the preferable way to obtain
gold price exposure.
Table 6.9 shows that the 6-month annualized gold lease rate is 1.46% in June
2001. Thus, by
physical gold instead of synthetic gold, an investor would lose
this 1.46% return. In June 2003 and 2004, however, the lease rate was about -0.10%. If
storage costs are about 0.10%, an investor would be indifferent between holding physical
and synthetic gold. The futures market on those dates was compensating investors for
storing physical gold.
Some nonfinancial holders of gold will obtain a convenience yield from gold.
Consider an electronics manufacturer who uses gold in producing components. Suppose
that running out of gold would halt production. It would be natural in this case to hold
a buffer stock of gold in order to avoid a stock-out of gold, i.e., running out of gold.
For this manufacturer, there is a return to holding gold-namely, a lower probability of
stocking out and halting production. Stocking out would have a real financial cost, and
the manufacturer is willing to pay a price-the lease rate-to avoid that cost.

Evaluation of Gold Production

Suppose we have an operating gold mine and we wish to compute the present value
of future production. As discussed in Section 6.2, the present value of the commodity
received in the future is simply the present value-eomputed at the risk-free rate-of
the forward price. We can use the forward curve for gold to compute the value of an
operating gold mine.
Suppose that at times t;, i = 1, ... ,11, we expect to extract
ounces of gold
by paying an extraction cost x(t;). We have a set of 11 forward prices, Fo I.' If the
value of
continuously compounded annual risk-free rate from time 0 to t; is reO, t;),
the gold mine is
II

PV gold production

[Fo,li -

x(t;)] e-r(O,li)li

(6.16)

;=1

June 6, 2001

265.7

269.0

271.7

1.46%

1.90%

June 5, 2002

321.2

323.9

326.9

0.44%

0.88%

June 4,2003

362.6

364.9

366.4

-0.14%

0.09%

June 2,2004

391.6

395.2

400.2

-0.10%

0.07%

Source: Futures data from Datastream.

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This equation assumes that the gold mine is certain to operate the entire time and that
the quantity of production is known. Only price is uncertain. (We will see in Chapter 17

8The cost of I ounce of physical gold is So. However, from equation (6.10), the cost of I ounce of gold
bought as a prepaid forward is Soe- oIT Synthetic gold is proportionally cheaper by the lease rate,