As gold speculators head for the tall grass, amidst a crash in prices last week, everyone is wondering if the gold bull market is still intact. The answer is unequivocally yes; however, don’t take your eye off the Libor rate for long.

It is likely the rising Libor rate which is being driven by new rules that are forcing banks to increase their liquidity, may be the culprit rocking gold’s world at the moment. So, forego the Fed blame game and all the meaningless hawkish words from the central bank for now. Check out below smack down in gold in case you missed it:

Gold Price Declines

chart source:

So, besides Fed officials raising concern (we’ve lost count how many times the Fed has made these idle threats) that the central bank will soon raise U.S. interest rates; what, is the real reason gold had its worst drop in 3 years last week?


Remember LIBOR?


LIBOR stands for the London Interbank Borrowing Rate and was made famous following several major investigations into Libor-rigging. Banks and individuals at banks were falsely inflating or deflating their rates to profit from trades. Former City and UBS trader Tom Hayes received an 11-year jail sentence for his role in the rigging. Libor is critical global interest rates, because it is designed to reflect the average interest rate at which large global banks can borrow from each other. When banks submit flawed or manipulated rates, a conflict of interest quickly arises.


Rising Libor rate sinks gold market in October

The three-month U.S. dollar Libor rate is performing exceptionally well in 2016 – up from 0.61% at the start of the year to 0.87% percent currently. That represents a 42% rise, according to Bloomberg.


This is a monster move. Especially when you consider that last year, Libor was estimated to underpin approximately $350 trillion in derivatives. The entire derivatives market is estimated somewhere north of $1 quadrillion. Let the gold market represent an annoying little fly in the eye of a Clysdale derivative market that Libor underpines. Derivaties are by far, the largest market in the world.


So, you may be asking… how does this relate to gold’s recent collapse?


Because the Libor is an average interest rate calculated through submissions of interest rates by major banks across the world, when it rises, the cost of money increases. This is in direct contrast to narrative that negative rates benefit gold. Furthermore, the Libor rate is rising for a specific reason.


On October 14th, the Libor will endure a money market reform.


The reform is designed to bolster a specific part of the Libor industry that was partially responsible for the financial crisis; most noteworthy, the new rules require prime money market funds to increase liquidity on hand.


In one giant cash call, Bloomberg has estimated, “Some $1 trillion worth of assets have shifted from prime money market funds into government money market funds that invest in safer assets such as short-term U.S. debt.”


Libor rates surging

While the move in the Libor fails to explain why gold wasn’t crushed earlier in July or August when Libor began its ascent. The proximity to the fast-approaching October 14th deadline has created somewhat of a sense of urgency.


Goldman Sachs has predicted Libor will reach 3.6% by the end of 2019 — or about 270 basis points more than today’s level. While gold has been proven to perform well in a rising interest rate environment, which does not serve the current narrative of negative rates well. Given the size of the derivatives market, it has hardly noticed gold’s decline. What might be occuring is, larger gold investors and institutions may be weary of a rising Libor rate.


Predictions, as we all know, are nothing more than educated (or politically motivated) guesses until they actually happen. In July of last year, I published an article titled The Fed’s Confidence Game Exposed, in which I explained, “The Federal Reserve reported that it had accidentally published internal staff forecasts for interest rates, unemployment and other key indicators, over the weekend.”


See below:

Fed Interest Rate Predictions

As you can see, if the Fed had followed through on those ‘leaked’ predictions the Federal Funds rate would be at 1.26% by now… not the 0.25-0.50% where it currently sits.


In conclusion, there has been a surge, potentially as much as $1 trillion worth of assets, shifting into prime money market funds which include short-term U.S. debt. This is without question in response to the October 14th deadline, which involves the market reform set to take effect for Libor. The gold bull market is not dead, but perhaps waiting to see how things look after the 14th deadline, this coming Friday. If we can learn anything about the derivatives market its that the system is still quite unstable and that the U.S. Dollar still makes up the majority of currency needed to back much of the debt. Finally, if trillions in assets are preparing for higher interest rates, there is no doubt it will have an impact on gold.



This article represents solely the opinions of Alexander Smith. Alexander Smith is not an investment advisor and any reference to specific securities in the list referred to in the article does not constitute a recommendation thereof. Readers are encouraged to consult their investment advisors prior to making any investment decisions. The information in this article is of an impersonal nature and should not be construed as individualized advice or investment recommendations.