I have been following Mr. Phillips for years on Goldseek. He's among the best analysts and one to stick closely to.
Julian Phillips outlines his view on gold leasing, and why, for instance, the Bundesbank has been slow to repatriate.
Author: Julian Phillips
Posted: Wednesday , 21 May 2014
Posted: Wednesday , 21 May 2014
Johannesburg (Gold Forecaster) -
Gold Leasing – to what extent
There is a belief that central bank gold in the custody of the world’s leading central banks such as the Fed, the Bank of England and the Banque de France has been leased out to the market. Central Banks have confirmed this, but it remains a source of contention. Even where the gold of the world’s central banks are held in the world’s leading central banks in a custodial arrangement this is so and it is reasonable to assume that this could not be done without the gold’s owner’s permission. This is what we do know;
In the first “Washington Agreement” and repeated in subsequent Central Bank Gold Agreements [from 1999 to now and onto September 26th 2014], a principle laid down in these agreements was;
“The signatories to this agreement have agreed not to expand their gold leasings and their use of gold futures and options over this period.”
Does this mean that existing leases, once matured would not be ‘rolled over’? Or does it mean that the total number of leases covering a specific volume of gold would be ‘rolled over’ but not increased in volume?
We think the latter, because the German Bundesbank was one of the signatories to all the Central Gold Agreements. Germany has requested that 150 tonnes of its gold be repatriated and has been told this will take seven years to achieve.
The difficulty in repatriating this gold is not in transporting that much gold, but clearly in receiving back the gold leased out to the market. Last year saw only five tonnes of this gold make its way home to Germany. We believe that all the signatories of the Central Bank Gold Agreements are in the same position as Germany with all their gold currently leased into the gold market.
Apart from Germany, which other central banks agreed to these terms in these agreements?
The signatories to the gold agreements were:
Oesterreichische Nationalbank - Banque Nationale de Belgique - Suomen Pankki - Banca d’Italia - Banque centrale de Luxembourg - De Nederlandsche Bank - Banque de France - Deutsche Bundesbank - Central Bank of Ireland - Banco do Portugal - Banco de Espana - Sveriges Riksbank - Schweizerische Nationalbank - Bank of England - European Central Bank.
We can draw the conclusion that there have been no increases in leasing futures and options overall since 1999 because none of them have increased their gold holdings in that period, but at that time the amount of gold leased into the market was all the gold in their reserves [so as to make a modest income on the holdings]. Why and how can we draw this conclusion?
If this was not so, why could the central banks holding Germany’s gold, not deliver the tonnage of gold asked for by Germany immediately? If only a portion of that gold had been leased the balance not leased could have been delivered.
But instead, only 5 tonnes of gold has been delivered back to Germany. The implication can only have one explanation and that is that all of it has been leased and only five tonnes of it has been returned to the Bundesbank. Some might argue that the gold needs to be re-refined. If that were the case then re-refining this gold would have produced far more than five tonnes in the last year.
The clause in the Gold Agreements looks very much like attempts to misdirect our attention into thinking that only a portion of that gold had been leased.
This has become even more apparent now that the details of the next Central Bank Gold Agreement have been released. No mention of leasing was made!
Where to store central bank gold
Gold investors may have thought that central banks hold and should hold their gold at home in their own central bank’s vaults. The reason central banks have gold in their reserves, in the first place is that if their local currency lost credibility internationally, they could turn to gold, in such extreme times.
If that gold were at home, its ability to act as collateral or even to pay the nation’s bills would be impaired, because it would have to be shipped to potential creditors first. By holding gold outside the nation it is instantly available. That is, provided it is not leased out. Yes, creditors may well accept the ownership transfer of leased gold because the owner’s ability to access it would have been removed, already. But it would lessen its accessibility, unless it was accepted practice that central bank gold almost in its entirety was leased!
The clear conclusion and only one that can be reached is that inevitably, all the gold of Germany and that of other nations held outside their borders is leased out.
Counter-parties to central banks
Who are the institutions to whom central banks lease their gold? They are the market makers, the Bullion Banks, who then onward lease the gold into the market to various counter-parties. It is very possible that if the gold price were to take off, these counter-parties would not be able to retrieve or buy sufficient gold to return the gold they leased. After all, China has absorbed so much of the gold available on the open market and elsewhere, particularly in the last year.
So as to understand what potential situations could come about in the gold market we look back at the de-hedging process that took place among the gold mines who had hedged their production since 1985 though to 2005.
Parallel situations – De Hedging
Gold mining companies found such a situation after the gold price moved up through $400 levels. It was at these levels that they had hedged their gold as the gold price was falling back from $850 to its low of $275 in 1999. Once the gold price moved through $400, the hedged position began to lose out on the rising gold price, much to the ire of their shareholders. To keep hold of such hedges would then have meant lost opportunities on the hedges and charges of speculation by gold mine executives. The gold miners who had hedged future production covered the broad spectrum of the gold mining community.
In all, the gold mines needed to find around 3,000 tonnes to de-hedge their positions completely. The gold market by itself did not have enough gold to accommodate the mining companies. Gold production was not rising, nor has it, despite the huge jump in the gold price. This was because of the huge cost rises and political risks that had grown over time in the gold market. The accelerated production of gold since 1985 had plucked all the ‘low hanging fruit’ of gold deposits during that time. The same situation applies today.
This is where the central banks stepped in. Under the “Washington Agreement” and the subsequent two other Central Bank Gold Agreements, they came to the miner’s rescue through their sales of gold at 400 or 500 tonnes a year up until 2009 when the gold mining companies completed their de-hedging. That covered not just 3,000 tonnes of gold but saw the gold price run up from $400 to $1,200. In 2009 it was no coincidence that these European central banks stopped selling and all central bank selling of gold came to a halt. Central banks were wise in announcing the sales they did from 1999 onwards as this disguised the rescue of these gold miners very well.
Failing Counter-parties to leased gold agreements
Now we see the central banks of the world fully committed to leasing gold as a source of income. But the volumes we are talking about could approach up to the entire gold holdings of the world’s central banks, amounting to over 30,000 tonnes.
Imagine if the gold price broke out to record highs over $2,000 an ounce or higher. How many of the current counter-parties to the leased gold deals would need to get hold of it in any way possible? We believe that the picture would parallel that seen amongst the miners in the first decade of this century. We expect that not just the counter-parties could be bankrupt but the bullion banks too. In turn the central banks would have to admit huge losses on their gold reserves, destabilizing the entire financial system.
And, this time round, there would be no other central banks to come to their rescue with supplies of gold! The gold market itself certainly does not have enough gold [annual production 2,800+ tonnes per year] available. Even a massively spiralling gold price would not produce sufficient quantities of gold to cover even a small proportion of this leased gold. The hunt for ounces of gold would be on.
This is where they need to find their gold from places other than the gold market. There is only one other place where they can attempt to source the gold from and that’s from you and other gold investors, dealers and custodians!
Julian Phillips is the founder of www.GoldForecaster.com and www.SilverForecaster.com