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Much has been made recently about the
“negative gold lease rates” derived from the London Bullion
Market Association (LBMA) statistical gold and silver data, but reporting on the issue so far has generally
lacked the background, substance and/or context required for many readers to
even understand what information is being provided much less draw proper
conclusions.
Here are some of the key points raised in our extensive analysis of the
subject at Metal Augmentor:
(1) The combination of a falling gold price and
rising forward rate is quite a bullish feature of the gold market that is
lost in the reporting on negative gold lease rates. An increase in the gold forward rate indicates
that owners selling gold will want it back once their immediate funding needs
have abated. Therefore it is really the reluctance to sell gold
outright that the market appears to be telegraphing via negative gold lease
rates. This is a welcome change from a gold market recently dominated by
weak-handed participants (Wall Street types like Paulson, Cramer, etc.) who
primarily look to gold for its ability to generate speculative profits during
periods of economic instability.
(2) The gold (or silver) lease rate does not necessarily
represent the actual rate at which lease transactions are being done in the
market. The published lease rate
is simply an indicated value derived from two related variables, the gold
forward rate and LIBOR. These rates can and do move in opposite directions
for reasons unrelated to gold leasing activity.
(3) We believe the focus on negative lease rates
misses the point of the current gold market structure and instead we should
be looking at changes in the gold forward rate. The gold forward rate has increased during both the late September
and current sell-offs in gold, which probably means that gold is being leased
by central banks in order to provide liquidity for the banking system.
Importantly, central bank gold is probably not being sold outright despite
rumors to the contrary. The implication is that the current gold correction
is similar to past events where gold has been used as a liquidity management
tool. Its use for such purposes is hardly inappropriate -- after all, gold is
the ultimate money and what good is money if it doesn't get used? In any
case, the eventual reversal of gold funding activity should correspond with
improved commercial bank liquidity and a return to gold's dominant price
uptrend.
(4) Important structural changes in the financial
sector could soon mean that gold’s widespread use as collateral and
eventually as money might actually not be that far off. If so, it would only be a natural progression for
an asset with no counterparty risk in a post-credit-bubble world. Excessive
leverage has transformed even the gold swap and leasing business, which by
definition is supposed to involve physical metal, into a paper form a number of years ago. While the recent reports from Bloomberg, Financial
Times and elsewhere offer shreds of truth about this condition amid all their
misdirection, they fail to examine underlying developments in the gold market
that may change the sorry state of affairs. Among the most intriguing is the
possible development of clearing and collateral facilities for 100% physical
backed gold, perhaps in the format of the LBMA unallocated bullion account.
We suspect that all this talk about “negative
gold lease rates” may represent the initial glimmer of recognition that
a major development is afoot in the gold market. Pieces of the puzzle are
being put together without most people really knowing or understanding what
the completed picture looks like. The general trend of the financial markets
thanks to the information age has been to move away from intermediation and
toward self-directed transaction. The tri-party arrangement redefines the
role of the intermediary so that it is no longer the matchmaker between
customers but rather acts as a clearing agent, administrator of collateral
and a funding backstop.
Importantly, in a tri-party arrangement one party
posts the collateral that the other party desires. And that desire for
specific collateral is where things could get interesting for the gold market
with gold being the ultimate collateral. In essence the selective collateral
nature of the tri-party format may force bullion banks to eventually declare
their unallocated LBMA gold accounts as backed by 100% physical bullion.
While there certainly will be gold appearing on the market from time to time
in the form of gold leasing or similar funding arrangements, the 300 year
history of archaic bullion banking may be coming to an end. If so, it could
ironically be JP Morgan that modernizes the gold standard by establishing
gold as the premier monetary asset with no counterparty risk and infinite
mobility.
Implications
The gold time bomb takes the form of a possible
panic out of paper gold into physical metal when counterparty risk reaches an
extreme level whereas a new gold standard would complement modern financial
markets by serving as the ultimate asset: gold with mobility and no counterparty
risk. We believe such a radical development could take shape if the most popular
paper gold product available today, the LBMA unallocated bullion account, is
used increasingly as a source of secured funding between counterparties
rather than as credit between a bullion bank and its customers. Indeed, if
the gold market is left to its own devices, the shunning of credit risk will
eventually lead counterparties to demand that gold be provided in the form of
risk-free collateral. The LBMA and bullion banks would then have no choice
but to establish and market 100% physical backed unallocated gold accounts
similar to BullionVault and GoldMoney,
except on a grand scale.
Tom Szabo
MetalAugmentor.com
Metal
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