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Gold Carry Trade

The gold carry trade was developed in the 1980s. It enabled central banks to begin earning money on an otherwise static asset class in their reserves and induced bullion banks and gold mining producers to profit from the spread between gold lease rates and dollar interest rates. Nearly all of the gold carry trade is transacted on the London Bullion Market (See Appendix I for LBMA information). This transaction takes place on the London market because it is an Over-The-Counter (OTC) market.

“The other advantage of the OTC market is its confidentiality and lack of transparency: business can be conducted privately, sheltered from the attention of other market participants, competitors, regulators and, of course, analysts! Gauging what is happening on the OTC market is more of an art than a science…Nevertheless, it seems that the following basic assumption holds good: under normal circumstances, the impact of the OTC market on physical supply and demand for gold bullion remains greater than that of the world futures exchanges.”

- Gold Fields Mineral Services (GFMS) Gold Survey 1996

The transaction typically goes as follows:

• A central bank loans a bullion bank some amount of gold with a lease rate and length of loan term attached to the contract.
• The gold loans were initially for 1, 3 or 6 month terms (currently, loan terms can stretch out as far as five and ten years).
• The bullion bank immediately sells the gold into the market and invests the profit of the sale in securities with a higher rate of return, such as government long-term bonds.
• The carry return is the return on the bonds minus the gold lease rate. However, this trade is risky because the bullion bank has effectively sold the gold short. If the loan is called by the Central Bank and if gold has risen in value, the bullion bank will have to go into the market and purchase higher priced gold. Indeed, if many banks are short, the unwinding of the gold carry trade could drive the gold price even higher.

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