View from City Road: Cover, tail and a gilts lottery

How do you tell whether a gilts auction has been a success or a failure? The conventional answer, which may not always be right, is to look at the cover and the tail. These terms, announced immediately after an auction, have nothing to do with the pursuit of game birds.

Cover measures how far the gilts on offer have been over-subscribed. In yesterday's auction pounds 3.32bn of bids was chasing pounds 2.75bn of gilts auctioned by the Bank of England, a cover of 1.21. This disappointed a market that had expected as much as 1.5 or 2.

The tail, the difference between the yield of the highest and lowest accepted bids - another indicator of the market's enthusiasm - was higher than hoped, at 0.02 percentage points. Gilts fell after the auction, recovering later.

In fact, an analysis by Simon Briscoe of Warburg of the performance of gilts after the last seven auctions suggests cover and tail are not a good indicators of how auction stocks perform afterwards.

It is true that the gilts sold in the two auctions with the best covers and tails did become star performers. But beyond that there was little pattern. The next best performing stocks were the two worst rated on the cover and tail measure.

The auction result is therefore something of a lottery, with the immediate result dictated to a greater extent than previously suspected by technical games played by market-makers.

And a modestly subscribed auction selling mainly to long-term holders among UK institutions - which is what happened this time - gives more support to prices in the weeks ahead than when enthusiastic overseas investors pile in and out for a quick profit.