There was a lot of excitement among gold aficionados last week. A $34-an-ounce end-of-week rally did a lot to brighten their spirits. Monday's $28 follow-through punched spot COMEX gold above the $800/ounce mark for the first time since October 20.

Gold rallied because ... because ... well, just what was the reason?

Some among the chattering classes would have us believe the spike was foretold by gold tipping into what they dubbed "backwardation." Well, not gold per se. Rather, gold forward rates.

Backwardation? Forward rates?

Maybe a little explanation's in order.

Backwardation, as described in several Hard Assets Investor articles (see "The Battle Against Contango" for one), exists when the price of a commodity for immediate delivery is higher than its price for later delivery. For a storable commodity like gold, backwardation implies scarcity of supply. Ordinarily, COMEX gold is a carrying charge market - sometimes ascribed as a "contango" market - in which contracts for later delivery are priced higher than spot to reflect the costs of storage. Because gold isn't consumed and supply is so visible, there's usually enough metal to carry forward.

Forward rates are the interest charges levied by dealing banks for borrowing gold. These rates are calculated for various maturities on a swap basis against U.S. dollars. A brief explanation of forwards can be found in "Gold Liquidity Play A Setup?").

Normally, the forward market looks like any other yield curve, with near-term rates lower than those of longer maturities. Those rates, too, are ordinarily positive. What was noted as backwardation last week was the quotation of negative forward rates in the London dealer market for one- and two-month gold loans.

That sent the discussion boards buzzing. "Does this mean banks will pay us for borrowing gold?" asked more than one denizen.

Don't you wish.

Gold Forward Rates

Sense can be made of negative forward rates once you understand how the metal is traded in the lease market. Just as changes in supply and demand affect metal prices, so, too, do changes in borrowing demand and lending affect lease rates. If gold is readily available, lease rates will be low; if the supply of borrowable metal is tight, rates will rise accordingly. Remember, though, we're talking about gold in the lease market here, not the cash metal marketplace.

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