Gold market panics as futures price falls

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The Independent Online
The gold market was in complete turmoil yesterday. For the first time since a brief episode in the 1970s, the futures price of the precious metal fell below the spot market price. "We've never seen anything like this," one dealer said.

The panic was exacerbated by hectic trading in gold options ahead of their expiry yesterday. Investors with options positions to hedge were forced to buy in the spot market, lifting the gold price by about $4, with bids in the range $383.40 to $388 in early trading.

Andy Smith, gold analyst at the investment bank UBS, said: "You will hear a lot of people saying that something cataclysmic is bound to happen."

For some commodities, "backwardation" - a futures price below the spot price - is not rare, but it is virtually unheard of in the case of the gold market.

The cause of this exceptional phenomenon is a sharp rise in the demand to borrow gold during the past three to six months.

As almost all the gold ever mined still exists, the main activity in the gold market is borrowing and lending. Gold producers borrow - and sell - current stocks of gold against their future output. The lenders are big banks, which in turn borrow from the gold reserves of central banks.

South African producers have started to borrow more gold recently due to a tight profits squeeze. The price at which they can sell gold, which is fixed in rand terms, has stopped increasing in dollar terms because the country's exchange rate against the US currency has been unusually stable.

The increase in their demand for long-term gold loans has in turn triggered a sharp rise in banks' demand for the short- term gold loans which are available from central banks.