Financing Precious Metal Holdings

Companies use precious metals in two main ways. First, they may use metal in their end products, which means that it must be acquired on an ongoing basis, for example in the automobile and electronics industries. Second, in many industries metal may be part of the production process, in which case it does not need to be continually replaced; examples include the glass, (petro-)chemical and pharmaceutical industries. Companies that need precious metals for their ongoing operations can either make a one-time purchase or arrange for a long-term loan.

Precious metal loans are most easily compared to borrowing money; in the legal sense, though, they represent the loan of a tangible good. The lender provides to the borrower a specified amount of precious metal for an agreed-upon time period, either though physical delivery or through credit in a weight account designated by the borrower. The parties also agree on an interest rate and a basis price (usually the current market price) that serves as the point of reference for calculating interest. In professional trading, loans are usually concluded for fixed periods (one, two, three, six, nine, or twelve months). Heraeus customers also have the option of loans for “odd” periods of time. The maximum duration of a loan differs from metal to metal, and depends on the volume of the particular market. Interest is generally paid upon conclusion of the term of the loan in the currency agreed on when the loan was granted (Euros or dollars), but only seldom in the form of metal.

Precious metal swaps

The term precious metal swap (also called “cash and carry”) refers to an arrangement that may be used instead of financing precious metal inventory through a “true” loan. In this case, metal and the monetary value of that metal are exchanged for a pre-defined period of time. The borrower receives the metal from the lender for the term of the swap and, in turn, pays the lender its monetary value. In effect, the arrangement involves an initial sale of the metal to the borrower with the understanding that the lender will buy it back at the end of the period.

In most cases the two components of this transaction, the initial exchange and the subsequent re-exchange, will not involve the same price. This reflects a difference between the interest rates for the metal and for the currency in question. For example, a company borrowing platinum would have to pay 2% interest to the lender, but it would be entitled to 3% interest on the dollars paid when the swap is agreed upon. In this case, therefore, the rate of interest on the swap would be 1% (3% minus 2%). The lender is required to pay the overhang of 1%, which compensates for an interest rate advantage.

After a swap transaction is concluded, the lender/seller delivers the metal to the borrower/buyer on the value date (normally two business days after conclusion of the agreement). On the same day, the equivalent is deposited in Euros or dollars, for example, in an account designated by the lender. The exact sum to be paid is determined by the basis price of the transaction as agreed by both parties, which in turn corresponds to the cash price when the deal is concluded. In contrast to a simple purchase of metal, in a swap the borrower bears no price risk, since the purchase and buyback prices are fixed and binding for both parties from the outset. The price difference merely balances out any differences in interest rate, but does not involve any economic advantage or disadvantage. It is important to consider the effects of a swap on the balance sheet. While in certain circumstances a loan does not have to be included in the balance sheet, a swap must be shown in the accounts if it continues beyond the closing date.

Two forms of swaps that occur only in the precious metal business include trading metals located at different storage sites (location swap) and trading metals with various grades of purity (quality swap). Despite the similarity of their names, however, neither of these arrangements is a financing transaction. Furthermore, the prices for the swap are not based on differing interest rates for the metal and the currency used, but on the costs of transportation and/or insurance, or of reprocessing to achieve a different level of quality.

At the beginning of the decade, it had become much more common for companies to increase their liquidity by selling their existing precious metal inventories and then leasing them back. Because of the temporary increase in interest rates for rhodium, amounting to up to 40% per year, and in view of short-term interest rates for platinum that rose beyond 100% per year, this has become much less common. This kind of transaction is purely “on the books”; the metal used in the production process is not actually affected. In any event, it is important in a sale and lease-back deal to take into consideration possible tax implications for the company (increase in hidden reserves).