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The big feature of last week’s decline in the
gold price has been the lending of gold into the market. Commercial banks
could have been doing it, but there is evidence in the past that central
banks have leased gold to cap the gold price and bring it down. The gold
price declines were so rapid and extensive that some investors theorized that
central banks, including the Federal Reserve, were actively selling gold. The
talk is that Commercial banks were unable to get the dollar liquidity they
needed, leasing gold under their wings to facilitate these loans at lower
interest rates. After the massive swap arrangements made between the U.S. Fed
and the E.C.B., many felt that the problems of dollar liquidity had been
overcome; however, by the extensive leasing of gold, this does not appear
true.
Last year, we saw
over 500 tonnes of gold for dollar swaps instituted, then reversed as the
swaps were completed. In light of central bank and Commercial bank lack of
transparency on their gold dealings, the possibilities are worth
contemplating by gold investors because we must discern whether we’re seeing
distress selling as banks flail for survival, or if European central banks
are attempting to hold back the gold price to stop it highlighting the
parlous state of the world’s leading currencies. We now
speculate…
If gold is being
leased, how can it make the gold price fall?
How could such
lending result in the gold price falling? After all, the gold must at some
point be returned to the lessor. What happens when gold is leased is that a
Central, Bullion, or Commercial bank will loan gold to an entity that would
sell that gold into the market for dollars.
Gold
Leasing from 1985
This happened on a
grand scale after 1985 when a host of central banks loaned gold primarily to
gold producers –who would finance future gold production with the
dollar proceeds ensuring they would have the gold to return to the
lessors—knowing that their gold would be sold and knowing they would
ensure that gold supplies to the open market would knock the gold price down
from $850 to much lower levels. They were successful in these moves, taking
the gold price to around $275.
But today, only a
very small amount of gold production is financed this way. The easily mined,
large gold deposits were fully developed last century, leaving only smaller
deposits available for mining. These cannot suddenly be turned on, so gold
borrowers are few and far between in the in the mining industry. Therefore,
who would want to borrow gold? Would gold manufacturers?
Unlikely, because
they would want to sell the gold and not return it. So whoever borrowed the
gold outside gold producers would have a position: long dollars and short
gold. Only someone who knew the gold price would fall (they would need facts
to convince them this was a low risk situation) or they would face a high
risk, when it came to returning the gold. If the gold price rose they would
find themselves in the same position as the gold producers were in when the
gold price turned back up. When gold producers saw the gold price stop
falling and turn back up, they were caught ‘short’. So many gold
producers eventually lost on their “hedged” positions. In fact,
around 3,000 tonnes of gold was “de-hedged” over time, and there
are only small hedged positions left in the market. What they believed was a
prudent situation, the gold executives found was a ‘short’
position in a rising market –the worst position company directors,
handling shareholder’s funds, could be in.
The big difference
from now on is that there are few gold producers that would entertain
borrowing gold today, no matter how cheap it could be. So who would want to
go long of dollars and short of gold in these markets with prices moving fast
and furiously both ways to the extent that interest rate differentials become
insignificant?
Who
is Leasing?
It could be
European central banks, particularly if they knew for sure they would
eventually get their gold back (as we mentioned earlier, provided swap
arrangements for major banks). Within the year, the swaps were unwound. The
banks knew the B.I.S. would not sell gold and hope to buy it back at the end
of the swap, so a swap arrangement such as these would not carry a price risk
because the Bank of International Settlements would not have ‘played
the market’ but simply held the gold until the swap matured.
Some may say that
it was gold lending by European commercial banks, but who would borrow from
them just for the interest differential, while carrying the risk of price
movements? Yes, it’s true that the persistently negative gold lease
rates provide an opportunity, but what a gamble with gold prices moving 3%
with ease, in just a day. Yes, gold leases are at their lowest levels since
1998, but is this really sufficient an incentive?
Is gold
being sold by Central Banks?
Market News International
reported that the Bank for International Settlements, the Bank of England,
and the Federal Reserve have been “good sellers of gold.” There
have not been any official denials of official selling.
Could it in fact be
the Fed? Unlike most central banks, the Fed does not have access to U.S. gold
reserves, which are held by the Treasury and can be sold only on the
instructions of the Treasury secretary.
Could it be
European central banks? They have a ‘Central Bank Gold Agreement’
in place with an annual ‘ceiling’ of 400 tonnes, so they have the
ability to do so. The problem is that the E.C.B. publishes, on a weekly
basis, the amount of gold sold within the Eurosystem.
The only amount sold in the last year has been under 10 tonnes and primarily
for coin production. So unless it has been sold in the last week, we would
know. No meaningful sales have taken place in the last year from Eurosystem banks.
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