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Thursday, July 17, 2008

The Gold Lease Rate is Negative!

According to this chart by Kitco, the 1 month gold lease rate was negative!

Of course, leasing gold from central banks is only available to politically connected insiders.

The sharp decline in gold lease rates indicates that central banks are dumping gold on the market, in order to push down the price. They are dumping so much gold that the lease rate is negative! They're leasing more gold than their politically connected buddies are willing to borrow!

I'll recap how you profit from gold leasing, and how gold leasing manipulates the gold price.

In a bona fide short sale, the short seller must deposit collateral equal to the value of the thing sold short. Suppose I short sell 100 shares of XYZ for $100/share. The proceeds of this short sale are $10,000. I can't just take this $10,000 and spend it. My broker puts this $10,000 in a special account. If the price of XYZ rises, I must put up more collateral. If the price of XYZ declines, then I can spend the profits.

For these gold leases, the central banks are requiring zero or negligible collateral. If there's a rapid increase in the price of gold, the gold borrower may default, and the central bank may be stuck.

Suppose I was buddies with a central bank. Here's how I profit. I borrow 1000 ounces of gold and sell it on the spot market. I buy gold futures. However, for the gold future, I only have to post collateral equal to approximately 5%-10% of the purchase price. I take the difference and invest it elsewhere, in bonds or in other assets. I am hedged, and make a practically guaranteed riskless profit.

Due to the lease, gold is sold on the spot market, pushing down the price.

The central bank carries the gold on its books at the face amount. The central bank has no obligation to disclose the amount of gold leased. This makes it hard for professional traders to determine how much gold has been leased and sold. If professional traders knew, they could profitably buy and correct for the market manipulation.

When the loans come due, the central banks don't demand repayment. They roll over the lease, extending the term. Alternatively, they sell the gold outright and don't demand repayment. If the central bank demanded repayment of the gold, this would drive up the gold price, which defeats the purpose of their manipulation in the first place! These leases can never be repaid! Even though the gold borrower can hedge via buying futures, they are under no legal obligation to do so. There have been instances where a central bank got shafted when a gold borrower defaulted.

A negative gold lease rate is a strong indication that banks are manipulating gold's price downward right now. They are flooding the market with gold.

I don't understand why gold investors whine about gold market manipulation. If you believe this to be true, buy gold! This may be an excellent buying opportunity.

Due to these complicated leasing arrangements, physical gold in your possession is the best investment. ETFs like GLD may be shafted if there's a default on the gold leasing market. GLD leases its gold for short selling. According to the GLD ETF's rules, the GLD shareholders take the loss in the event of a default.

Regrettably, I don't own any physical gold. I should buy some. However, manipulation of the gold market should continue for a few more years, until central banks exhaust their gold supplies.

According to Google Analytics, this post has been getting a surprising amount of traffic.

The Anonymous commenter pointed out an error. I thought that a negative gold lease rate meant a negative absolute rate. A negative gold lease rate actually means a negative rate relative to LIBOR. I couldn't find a source where this is clearly explained, but the correction appears to be right. In other words, a gold lease rate of -0.25% means that the gold lease rate is 0.25% less than LIBOR.

Still, a negative gold lease rate means that gold borrowers can make a guaranteed riskless profit. They borrow gold, sell it on the spot market, buy gold futures, and invest the proceeds in bonds. The gold borrower has a free put option to declare bankruptcy and default on the lease. The proceeds of the short sale could be invested in riskier assets than bonds.


barry b. said...


I've got a gold 'ticker' in my sidebar and it's had gold from 980 down to 920 and back up to 975 this weekend. right now shows 963...


Anonymous said...

The quoted lease rate is simply the difference between LIBOR, the rate that banks purportedly charge each other, and GOFO or gold forward offered rate, the cost of carry of a forward contract in gold. A negative number does not mean bullion banks will actually pay someone to borrow their gold. It does probably mean that the LIBOR rates are being held artificially low, or are being misreported. It also means the demand for borrowed gold for shorting is low.

Duke said...

Why "correct" yourself on account of "anonymous"? Your initial inclination is correct - a negative lease rate implies that GOFO is higher than LIBOR, not the other way around(see Negative rates may therefore imply that the lender of gold is leasing his gold at a theoretical market loss. It does not prove manipulation but justify suspicion. The real issue is this, why do the central banks or gold industry not come clean and disclose historical data (say 3 months in arrears) i.e. ounces leased, to what type institutions and if any of these leases were rolled over or gold not swapped back. Such data should not compromise any one but it would clear the air to some degree.

Richard Noble said...

You say: "I borrow 1000 ounces of gold and sell it on the spot market. I buy gold futures..." and then go on to say ...
"Due to the lease, gold is sold on the spot market, pushing down the price."

I disagree. In your example the trader buys and sells the same amount of Gold. Note that at delivery paper gold becomes physical assuming no delivery failures.

Perhaps you meant something else and I would be delighted to know what you mean.

mike said...

to Richard Noble: this is from what I understand...
You are partially right, however buying gold futures is a derivative of gold just like cash once was, it has very little to do with the gold itself unless someone takes delivery, which rarely happens, just as when cash used to be backed by gold, very few people redeemed cash for gold.
Supposedly there's more gold futures than they think exists in the ground, just as while still on the gold standard if there was a run on the banks to exchange dollars for gold, there would not be enough gold in the vaults. Similarly, if there was a run on the futures there would not be enough gold available for everyone to execute, perhaps even if the mines around the world extracted every bit of gold that they could. Even if their was, the sellers of futures, wouldn't be able to pay for them, and the demand would shoot up so much that the sellers of futures would go bankrupt. People exchange gold futures just as people exchanged dollars, they had little use for the gold itself so the sky is the limit on how many futures can be created...

What this means is that the physical gold is taken out of a vault and sold, and replaced with theoretical gold that may or may not exist.
In addition, one gold is moving, the other is invisible and non existence. If you had a supply of X gold, but 2/3rds of that was stored in vaults, the real market would not be X, but instead 1/3rd of X. If all of a sudden the 2/3rds of X gold comes into play, there's more supply being actively traded, so the supply absorbs the demand. It doesn't matter if it's replaced with gold futures or not, gold futures are a piece of paper giving you rights and obligations about the gold. I dont understand futures as much as options because I haven't really studied them 100%, but I think that if more and more futures are created to offset previous futures instead of people actually buying and selling the physical, they are replacing them with additional futures, and as more futures are created and less people take physical delivery, the less relevant transactions in futures are to the actual price of gold. I've heard that people have the option on what type of future they buy, one actually is based on physical delivery, and the other is not. Even if everyone had to take physical delivery, it's still not the same, because it supresses prices until the demand is actually created. However, there is not enough physical gold in existence for every single future to allow people to all take delivery but if there was, people would not be willing to sell it at a price that the sellers of futures can afford.

If I have something wrong about the futures let me know

Anonymous said...

fail - this guy has no clue.

Anonymous said...


didn't you mean central banks, not bullion banks when you mentioned paying someone to borrow gold

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