Precious Metals, Storage Costs, and Futures Convenience Yield

Summary

The document distinguishes precious metals from foreign exchange when describing spot-price dynamics under a risk-neutral measure. In FX, the domestic and foreign interest rates reflect the ability to invest in short-term sovereign instruments in each currency. The response explains that spot precious metals do not have an equivalent foreign risk-free rate because holding metal does not generate that cash interest flow.

Instead, storage costs can make physical metal costly to hold, while futures prices reflect factors including convenience yield, time value, and demand across maturities. The answer recommends viewing gold as a commodity for valuation rather than treating it as a currency. This is a conceptual explanation, not a quantitative pricing model; it does not specify how to estimate storage costs or convenience yields, and its broad statements may not capture every market or instrument convention.

Key ideas

• FX interest-rate differentials reflect cash flows available from investing in the two currencies.
• Spot precious metals do not have a foreign risk-free interest rate in the same sense as FX.
• Storage costs can make physical metal costly to hold.
• Precious-metal futures may reflect convenience yield, time value, and tenor-specific demand.
• Commodity valuation can be a more useful framework for gold than currency valuation.

Tags

# Some questions of precious metal Futures


# Some questions of precious metal Futures












We always regard precious metal as a FX rate e.g XAU/USD.

Is there any concept of spot rate for precious metal? If yes, then we know the dynamic of FX spot rate under risk neutral measure can be written as: $$\dfrac{dS}{S} = (r^d-r^f)dt + \sigma dW.$$ Here $r^d/r^f$ is domestic/foreign risk free interest rate. But for the precious metal e.g. XAU/USD, $r^d$ can be risk free interest rate of USD, what's $r^f$ here? Can anyone tell me the meaning in real market?

## Answer by PlantFox (score 2)

https://quant.stackexchange.com/a/42815

There is no interest rate associated with spot PMs. The reason why FX is evaluated in this way is because you can invest in short-term sovereigns (risk free rate) and get cash flow. So the FX rates are partially determined by the differentials between rates. PMs are quite different. If anything spot PMs are a negative yielding asset because of storage costs. There is a yield associated with the futures due to convenience yield / time value / demand for different tenors. It might be more useful from a valuation context to view gold as a commodity, not a currency.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.