Legs

From the comments under the last post, it seems that a few of you don't understand what I do. But that's OK with me. I don't need to be understood.

I think someone wrote "I'm not convinced." Ha! Good, I hope not for your own sake! That doesn't mean that I think my post was wrong, just that if you feel that way strongly enough to post a comment about your own state of mind then you might want to check your expectations at the door. ;D

I can also tell from the amount of support that came in through email and Paypal that a lot of you do understand what I do and, more importantly, that you appreciated the significance of what I did in those three posts. But for the rest of you, I'll post this again and keep posting it as often as it is needed:

FOA: "I (we) expect none of you to consider anything said here as credible. Everything is given as I understand it. If you came with a notion that I am someone who sees the future, grab the children and run far away. For these Thoughts, and my ongoing commentary, are meant to impact exactly as the "gentleman" said they would. People hear them, and whether believed or not, the words leave a mark. A mental mark on the trail, if you will. And later, after the world turns, our little "stacks of rocks" will be easier to understand next time you are passing this way. In fact, your ability to find your own way will forever be enhanced for having seen this path in a different light."

For the benefit of those who are still lugging around their preconceived notions, allow me to briefly clarify a few things. I do not know anything special. I do not do technical analysis. I do not provide any tradable information. I do not have any inside knowledge. I am not FOA. All I do is unwind the trail that he exposed a long time ago and then share my understanding with you for free. What you do with it after that is up to you. I do not give unsolicited advice nor do I put my opinions "out there" beyond the confines of my own space. If you are reading what I wrote, then you must have come to me, because I didn't approach you. So if you don't like what I do, then by all means please find something more useful to do with your time.

"Official Support" – Then and Now

There were also some great comments under the last post and a few good questions. I'd like to take a closer look at one of them in this post and, hopefully, kick off an interesting discussion. Max De Niro asked:

"How is that the ECB supports the paper gold market? Do they buy COMEX contracts, LBMA unallocated? Where would this show up on their balance sheet?"

Along the same lines, Tintin wrote:

"A quetion about possible ECB support for the paper gold market, or the withdraw of such: How do they do it? […] So you see, I am struggling with ECB support = higher POG or withdraw of ECB support = lower POG."

These good questions highlight an issue that I think is worthy of further discussion. So let's take a closer look at it.

I'm expecting a lower POG simply from the force of "gravity". In the post I proposed two legs of support for the paper gold market: 1.) the bull market in paper gold (private support), and 2.) official (CB) support. I said that "support" does not always mean a higher price (in the early- to mid-90s it did not), but that today, price levitation does reveal support coming from one (or both) of the two legs.

So the withdrawal of ECB support would simply let the "paper gold bull market" (private support) battle it out with gravity. It does not mean an immediate free fall in the POG (I presume "official support" is only occasional), but it means that if something goes wrong, like a general market decline, there might not be the "emergency support" that there was last time.

Think of it as two separate markets, physical gold and paper gold, which are presently attached to each other. Imagine that the physical gold market is like a beach ball being held underwater and that the paper gold market is like a lead weight also being held underwater. "Support" is simply whatever keeps them attached to each other. Most people think they are inseparable, just like most people think the dollar can't hyperinflate. In both cases it is "support" that is forestalling the inevitable.

Back in the 90s ANOTHER told us that when a CB sells gold, it is to a specific buyer, off market so as not to influence the price, but when a CB leases gold it is for a purpose, to buy "something" for the market. So what is the difference between a gold sale and a gold lease? I think the distinction is worth a closer look.

For one thing, if you want to buy some amount of spot or physical gold, normally you must have already accumulated surplus currency equal to the amount of gold that you want to buy (e.g., a Giant or just an everyday saver). Not so for a lease. To lease that same amount of gold you only need a business plan or an outlook that will yield more than the interest on the loan (e.g., a bullion bank, a mining company, a hedge fund or a gold fabricator). A lease is a two-legged deal. In essence, a lease is simultaneous spot and future transactions in opposite directions.

A CB that is leasing gold is taking a position that is essentially short spot gold and long future gold. Spot gold may occasionally mean physical, but not necessarily. This position "supports" the market (keeps the two markets attached) at times when the private market is running in the opposite direction—long spot gold and short future gold. This "running in the opposite direction" occasionally leads to the backwardation seen on the lease rate or GOFO charts because future gold loses its contango (its premium) over the spot gold price. It is similar to OBA's "rush to the Here 'n Now."

Now let's think about spot gold that is not physical gold. If it's not physical, then what is it? It is simply a non-interest bearing account denominated in gold ounces (or XAU) rather than dollars (USD) or euros (EUR). The equivalent of an interest bearing account in gold would be a lease, as long as the market is in contango. In other words, if you want to earn interest on your gold, you lend it out. You sell your spot gold, buy future gold at a slight premium (but you only have to pay a small deposit to lock in your future price), and then you use the rest of the proceeds from your sale to earn your interest in dollars from money markets or Treasuries.

The point is that interest comes from currency, not gold. Gold doesn't reproduce itself, it just sits there. You can't buy spot gold and come back a year later to find more gold. But Treasuries do, somehow, reproduce dollars. You can put in $X and come back a year later to find $X+n dollars waiting for you. To make money from gold you must sell it, buy it back later, and make money lending the currency during the time in between. Spot gold (XAU) accounts are the same. If you want to make money you must sell your spot gold (even if it's just a book entry) and buy it back at the future's price, earning interest with your currency in between.

Another way to look at the difference between borrowing and purchasing gold is that it only makes sense to borrow gold if you think the price is heading lower (or at least flatter than interest rates). If you borrow gold, you profit when the price falls. Buying gold, on the other hand, makes sense either A) if you think the price is heading higher (Western/shrimp view) or B) if you view gold as real wealth (Eastern/Giant view).

According to a World Gold Council (WGC) research paper back in 2000, the mining industry was the greatest user of lent gold, and central banks were by far the largest lender. According to the survey conducted for the paper, 90% of the gold on loan came from central banks. [1]



The mining industry was essentially borrowing XAU (spot gold) credits and paying them off with physical down the road. But they couldn't spend XAU—what they really wanted and needed was dollars. So the bullion bank would assist the miner in selling his borrowed "spot (paper) gold" into the "gold" market and the producer would get the dollars he needed and could later pay them off with a pre-determined weight of physical no matter which way the price went in the meantime. And back then, the price was often falling, sometimes below mining costs. So this was a good deal for the miners.

There's also another way to think about these two-legged deals. It could also be said that the miner was simply forward selling his future gold production for a cash flow of dollars in the present, locking in a good sales price in the process. The counterparty to this deal, the bullion bank, would then be long future gold and, to offset this long position, would short sell spot gold, borrowing it from the CB and selling it to the market. Here's what another WGC research paper, this one from 2001, said about it:

"Transactions in the derivatives market, whether they are motivated by the need to hedge future production, or to hedge the risk of holding gold in inventory, or simply by speculation, tend to be seller initiated. The other party to the transaction – typically a commercial bank or some other intermediary – will seek to hedge its exposure to the gold price by selling in the spot market (normally borrowed gold). The sale of gold in the forward market therefore generally leads to a sale in the spot market.

When the derivative contract matures, the spot market hedge is removed, and the bank buys back the gold. Thus the effect of hedging by producers and fabricators is to bring forward or accelerate sales in the spot market. The volume of sales brought forward is equal to the net short position of hedgers and speculators.

So long as the net short position is stable, with the initiation of new contracts being offset by the maturing of old contracts, the effect on the spot market is neutral. But over the decade of the 1990s the amount of hedging increased rapidly, with much of the increase occurring in the second half of the period. The net short position increased by a total of some 4,000 tonnes, or around 400 tonnes/ year on average. To put the point another way, to meet the demands of the derivative markets, holders of gold increased their lending of gold to the market by some 4,000 tonnes." [2]

Now let's take a look at what ANOTHER wrote about it.

Date: Fri Nov 28 1997 23:29
ANOTHER (THOUGHTS!) ID#60253:

The BIS set up a plan where gold would be slowly brought down to production price. To do this required some oil states to take the long side of much leased/forward gold deals even as they "bid for physical under a falling market". Using a small amount of in ground oil as backing they could hold huge positions without being visible. For a long time they were the only ones holding much of this paper.

Date: Sun Nov 16 1997 10:20
ANOTHER (THOUGHTS!) ID#60253:

It is not only important to understand this question, but also to ask it in context!

Date: Sat Nov 15 1997 20:14
Crunch ( Question for Another ) ID#344290:
Another, a question, please: When gold is borrowed from CBs, what collateral is required by the CB to be assured the loan will be repaid in full?

Crunch,
If you will allow, I will add to your thinking. In todays time the CBs do not sell physical gold with a purpose to drive the price down. They sell to cover open orders to buy what cannot be filled from existing stocks. Look to the US treasury sales in the late 70s. They sold 1 million a month using open bid proposals with much fanfare. If the CBs wanted physical sales to drive the price they would sell in the same way.

The sales today are done quietly with purpose. The gold must go to the correct location. That is why these sales do not impact price as they occur, there is a waiting buyer on the other side. As all of these transactions are done thru certain merchant banks, not direct CB contact, the buy side does hold hedges.

When actual delivery takes place, months later ( and usually at the same time as the CB sale statement ) these hedges come off and affect the market price.

[…]

[Central] Banks do lend gold with a reason to control price. If gold rises above its commodity price it loses value in discount trade. They admit now to lending much where they would admit nothing before! They do this now because of the trouble ahead. Does a CB have collateral to lend its gold? Understand, they only lend their good name on paper, not the gold itself. The gold that is put on the market in these deals belongs to someone else! The question is not "Are the CBs worried for the return of gold?" but, "Has our paper been lent to the wrong people?".

Date: Wed Nov 12 1997 14:08
ANOTHER (THOUGHTS!) ID#60253:

All CBs will now slowly stop all leasing operations and allow the market to size itself. The important players, the oil states, will have their paper covered without question! But, for all others, the great scramble is about to begin!

With this statement, ANOTHER explained the implication of a recent Bundesbank statement following a BIS meeting that would materialize two years later as the Central Bank Gold Agreement (CBGA), which read: "4. The signatories to this agreement have agreed not to expand their gold leasings and their use of gold futures and options over this period."

Date: Sat Nov 29 1997 15:53
ANOTHER (THOUGHTS!) ID#60253:

Something interesting happened just ago that will, in time impact the price of gold in US$. A proposal was offered to borrow in broken lots, 3.5 and 5.5 million ozs for resale. It was turned down. The owner offered to sell only, no lease. What turned heads was that someone else stepped in and took it all, at a premium!

Date: Fri Dec 12 1997 21:06
ANOTHER (THOUGHTS!) ID#60253:

The paper gold market controlled by the BIS/LBMA system is, alone equal to more than all the gold in existence. This market works like a hybrid currency using approximately twenty to forty percent of all CB gold in leased form as backing. The paper behind the lease is a form of CB/gold and is used as a "fractional reserve" that has built this huge market. This system has worked and does work well. You have but to look at the good value that is received when dollar debt ( digital currency ) is purchased with oil. The world works! But this system cannot continue. There is a limit to how far gold can be inflated in quantity using "fractional reserve leasing" as backing. The fatal flaw was found in the "forward sales" of unmined gold. The whole system counted on the expansion of cheap mining techniques to supply much more gold at a cheaper price far into the future. This happened to a degree for a few years but then just leveled off.

Now the LBMA continues to flood the market with paper gold as if nothing has changed! But it has, we reached production cost! That wasn't supposed to happen until the mining industry had raised supply many times what it is today.

[…]

Will the BIS try to settle this unbalanced market by destroying LBMA? Or will they drive the CBs to lease another 20% in an effort to inflate this "paper gold currency". Just like the fiat dollar, if inflated it loses value. This is not lost to the oil states.

Here's what the WGC survey found two years later, immediately following the Washington Agreement (CBGA):

"On average, the official sector lends 14% of its declared gold holdings. However the proportion varies substantially from country to country. If the USA, Japan, IMF and major European countries that do not lend are excluded the proportion rises to 25%.

[…]

The mining industry is thus the greatest user of lent gold. Short speculative positions exist but appear to be of lesser size.

[…]

Hedging has enabled producers to realise higher than spot prices in recent years. However the mining industry is facing a number of derivative-related challenges:

- the total costs of marginal producers in North America and Australia are not being fully covered by average realised hedge prices. South African producers are faring better but their position may not be sustainable in the longer term;

- the Washington Agreement has precipitated a review of hedging practices by both mining companies and bullion banks. Well publicised difficulties with two hedge books have prompted a swing away from the more complex products. However since the more complex products have facilitated the achievement of higher realised prices, this could render hedging more expensive;

- the majority of producers have not been subject to margin calls on their hedging agreements. However the events of September 1999 have caused bullion banks to review the issue with the possibility that additional hedging premiums may be levied on mining companies that are deemed less creditworthy;

- the sharp decline in exploration expenditure implies that the reserve base is not being replenished. This has implications for existing credit lines and the ability to hedge reserves in the ground;

- the introduction of the FAS133 accounting system will also influence the choice of hedging products in the future.

• The bullion-banking industry has been subject to extensive restructuring in recent years. This has had a substantial effect on available credit. Banks’ trading limits have declined in recent years and are currently collectively likely to total some 2.5-3.5m oz (75 to 110 tonnes) of combined short-term net exposure.

• No evidence was found of any collusive behaviour on the part of market participants to manipulate the price." [1]

Date: Fri Mar 20 1998 22:12
ANOTHER (THOUGHTS!) ID#60253:

I hope all persons could see the "new" true nature of the Central Banks this week. I call it "The change that did happen"! If you read the post of Sat. Mar 07 1998 13:08 Another, that was written for me, it speaks of it all. The [central] banks do want gold to rise now, and they will pull in physical gold to replace leases, even if they must "pay high on the market". They do not rollover these loans now.

Here's the post that ANOTHER said someone else wrote for him:

Date: Sat Mar 07 1998 13:08
ANOTHER (THOUGHTS!) ID#60253:

The Management of Gold, A Simple Tool for the 90s

For any currency to maintain a "reserve" status, it must be, in some fashion, convertible into gold! In the past, the US$ was freely exchanged for a "fixed" amount of gold. $20 dollars was equal to one ounce. If the country wanted to make its money stronger, it would lower the amount of currency units fixed to one ounce. $10 dollars per ounce made the currency more valuable in the market and it would buy more things. Also, a country could decrease the value of its currency by raising the number of units to the ounce of gold, say $40. The problem with the "fixed" gold system is found in matching the amount of gold in the treasury to the "fix"! To make the money stronger, one had to bring in gold, as it took twice as many ounces to back a currency "in circulation" at $10 as it did at $20! The reverse is true when lowering the money value to $40. Then, one half the treasury gold backing had to be removed as only half was now needed to back the dollar.

You have probably not read this "slant" on the past gold standard because it was never quoted in quite that way, nor looked at in that fashion. If you allow your mind to perceive the above, one will clearly see that it was gold that gave the currency value. In that time one did not look to see how many dollars gold was valued with, rather, how much gold was bid for each unit in circulation!

Today, the world reserve currency is not on a "fixed" gold standard, it is on a "freely convertible" gold standard. One may, anywhere in the world, convert US$s into gold. This new "freely convertible" standard does still allow the dollar to be backed by gold for those who still demand a gold "fixing". That requirement is enforced by a certain commodity, oil. Yet, there is a price for the benefit of having all oil sales settled in US$. Yes, even in this modern era, for the US$ to remain on an "oil standard" it must be on some form of "gold standard"! Regain the perception in the top paragraph. Then understand that for oil to back the dollar, the dollar must find value in gold. And the dollar finds more value if it is fixed by the "freely convertible" gold standard, to buy more gold!

This convertible gold market is old from the mid 70s but is new from the early 90s. It is old by the 70s because it is "freely convertible", but it is new by the 90s as it "is not" "freely tradable"! The US$ price of physical gold is no longer "fixed" from supply and demand, rather it is "created" through the market action of "paper gold". Truly, it is the US$ has become the "item traded" in the "paper gold" market, not physical gold. Participants have yet to realize that the gold futures, gold options and gold forward markets, worldwide, have become little more than currency trading arenas. The percentage of gold delivered against these markets has grown so small as to be nonexistence when compared to actual metal settled at closing. Physical gold does still move, and in size, but this is little or nothing compared to the "paper gold" traded.

We are brought to this point for a purpose, but how did we get here? The largest producers of gold were introduced to the use of large scale "forward contracts" by the Bullion Banks. Once the process started, good business required it to expand. Shareholders want maximum profits at all price levels and "forward deals" were good at any price of gold. Once hooked on "hedge profits" during the good times of a high gold price, the mines now "must have at all cost" "forward deals", just to survive. Some say the mines will not forward sell at these, break even prices. However, the shareholders say it's better to hedge now, for a lower price will bring doom! With the US$ price of gold holding at just above average break even levels, and the ensuing virtual bankruptcy of several well known companies, it appears that the mine owners are correct.

Understand, that many entities lend gold, but it is the CBs that started and do most of it. Their purpose was to create a "paper gold" market that would allow them to manage the "freely convertible" price of gold. The CB lends the gold to a bank that sells it on the open market. ( Usually, the gold is placed privately as it must go to the correct destination. ) Then the bank holds the money and draws interest as incremental payments are made to the mine for new gold delivered against the contract. Over the long period that a mine takes to produce and repay the gold, this money grows. To grasp the fact that the CBs had a plan, is to know that they lend the gold for only 1% or 2% while the proceeds set in a Bullion Bank and grow with interest for the benefit of the BB and the mine! And further, the lenders allow the return of the gold to be extended out for many years, as in "spot deferred". The CBs allow public opinion to think of this as "typical government stupid", it's not!

Now that the gold price in US$ is around production cost, most mines must use "paper gold" to survive. The gold industry is coming under [central] bank domination, without signing away any sovereignty! Slowly, the CBs are gaining the ability to manage production and price with this simple tool.

"If they want new mine supply on the market, they roll over the contract to the BB. If they want new supply off the market, they allow the BB to pay for and take delivery of the gold and return it to the CB vault." "Also, by offering ( or withholding ) vault gold from lease, they affect the lease rate and thereby control private lending as well"

Understand that the second sentence action is used because gold lending is done by many different entities. Many times a mine isn't even involved. Sometimes, gold isn't even involved, just paper. But, it's still based on the gold price! The paper price, that is.

thank you

Date: Sun Apr 19 1998 15:49
ANOTHER (THOUGHTS!) ID#60253:

Date: Sun Apr 19 1998 14:31
mozel ( @ANOTHER ) ID#153102:
"Was Gold Leasing by CB's an accidental mistake or an intentional mistake do you think?"

Mr. Mozel,
This world of money, it is a fierce one! I ask all, does anyone know a money manager with money for loan at 2%? No? Does not even the bank of Canada sell gold outright and receive "high" interest on cash? Is a CB that sells/leases gold dumb? NEVER!

If they sell gold, a way is clear to "bring gold back" for the nation! Canada has local mines, Australia has local mines, Belgium has South African mines! If they lease gold, it is for a purpose to buy "something" for the new supply to the market! The interest on the loan is for public view, as a "free gold loan" is not acceptable!

It truly started with Barrick, in Canada in the 80s. It was a "thin market", but grew big in oil. I think "intentional mistake" that was, as is said, "trial balloon"?

Thank You

8/10/98 Friend of ANOTHER

The Euro has, in effect already been dispersed in the form of Gold Leases not gold sales. One has only to look at the official gold holdings of most central banks to see that physical gold sales are little more than the average, with a good amount of that coming from nonEuro countries. Gold is a funny thing, it can be sold many times and pass through many countries and still remain in a CB vault. Truth Be told, some 14,000 metric/ton have been sold this way. Far more than the street thinks. Using this amount it's easy to see how certain entities have moved off the dollar standard in the last few years. If we use a future price of $6,000+US, the move is about complete.

The process: An oil country (or others) goes to London and purchases one tonne of gold from a Bullion Bank. The BB borrowed this gold from the CB (leased). The one tonne gold certificate is transferred to the new owner. The gold stays in the CB vault and the owner goes home. The CB leased this gold to the BB and expects it to be returned plus interest. The BB financed the Actual Purchase of this gold mortgaging assets of the buyer. The BB, who created the loan, then uses the cash arranged in this venture to contract with a mining company (or anyone wanting a gold/cross financing deal) to purchase production gold, using this cash to pay for it. In the eyes of the mining company, the BB just sold gold on the open market, for cash, and will purchase future production at the contracted price. The mine does not know where the gold came from, only that it was sold and a fixed cash price is waiting. Of course, most of this made more sense when gold was higher. There were thousands of these deals, structured in every possible fashion. Look to the volume on LBMA and you see where the future reserve currency is traded today!

9/3/98 Friend of ANOTHER

Poland and China are good customers for the BIS. This is real physical gold they are taking out of circulation, not the pay me back when you have a chance lease deals. They really do have the IMF/Dollar countries over the barrel. Under these conditions it's easy for them to drain the Canadian gold reserves. Soon, these goldless countries will be left with nothing but high yield US dollar treasury notes.

[…]

My understanding is that whatever collateral was freed up from the USSR , the BIS picked up for others. It left the brokers selling leases for almost nothing or 1/2% or so. No one was buying them so the rate just fell on no volume. This was a lucky move for them as the perception was that massive sales were taking place. I don't think the BIS wants to be seen as a currency destroyer so they are doing the buying quietly.

8/19/98 ANOTHER (THOUGHTS!)

I think, now it comes time to sell the dollar. As the Belgian gold was purchased to replace dollars, it did announced the end of EMCB leases. Now the BIS transactions do create a gold market that is "not as before"!

We watch this new gold market together, yes?

Thank You

Another

Then and Now – Two very different paper gold eras

Before we move on to 2001 and beyond (i.e., this), let's recap the 90s. From the beginning of the 90s until that last comment by ANOTHER, about nine long years, the $PoG declined from $400 to $280. To put that into perspective, it would be like gold falling from today's price down to $1,150 by 2022. In terms of the long timeframe and the absolute price decline, that would be pretty discouraging for Western goldbugs, wouldn't it? Yet this discouraging era didn't faze those in the East who already knew physical gold as tradable wealth in the least.

What we have here are two very different eras in the "gold" market. The turning point may appear to be 2001 (if we simply look at the gold chart), or the CBGA in late 1999, but the turning point was actually January 1, 1999 with the successful launch of the euro. And from the excerpts above we get a clear picture of the "official support" which helped keep the physical gold market of the East attached (or fixed) to the paper gold market of the West during an era of a declining price.

Official (CB) gold sales were all done off-market so as not to affect the price. (The BOE "Brown's Bottom" auctions were different, but they were also after the launch of the euro.) In fact, we will never know the price or details of these official sales. All we know is that ANOTHER said that physical gold did continue to move "in size" during this era. He even mentioned one CB-sized sale that, presumably, was not by a CB because of the way he told the story.

Someone had 280 tonnes for sale in 1997. Someone else, presumably a bullion bank, offered to lease that gold from the owner in two lots of 110t and 170t, but the owner wasn't interested in a lease. He only wanted to sell. And the interesting part of the story is that when he insisted on selling, "someone" (presumably a proxy for the BIS or a buyer arranged by the BIS) stepped in and bought the whole lot "at a premium" (presumably to keep the sale "off market").

So here we can imagine CBs both buying and selling "at a premium" in order to keep physical gold "in size" moving to wherever it needed to go without affecting the paper gold market price. What was the premium? I can only imagine it was a bit different for the guy dumping 280 tonnes than it was for someone seeking to buy a similar amount. And ANOTHER did give us a hint at the latter.

Leasing was a different story. Most of the leased gold came from official sources, and that did not include the US, the IMF or Japan. The CBs participating in this leasing practice during the 90s lent between 14% and 25% of their reserves per the WGC, and between 20% and 40% according to ANOTHER. CB lending grew from about 900 tonnes in 1990 to at least 4,710 tonnes in 1999 (other estimates take it as high as 7,000 tonnes). The CBs finally admitted to this practice and then a couple of years later announced that it would be curtailed.

The standard explanation for CB gold leasing is that the CBs wanted to earn some interest on an idle asset. ANOTHER said that this explanation was nonsense. He said it didn't even make logical sense unless you thought central bankers were dumb. He said they were not dumb, that they had a plan and a good reason for leasing gold. He also said that the low lease rate was merely for "public view" because "a free gold loan would not be acceptable." The WGC and the MSM all bought the "CBs want to earn interest on their idle asset" story. I guess you can decide for yourself if it makes more sense than ANOTHER's explanation.

That was Then, This is Now

In the 1990s, the supply of leased gold came mostly (~90%) from the CBs. The majority of the demand for this leased gold came from gold mine hedging operations (~60%). Another small portion of the demand (~8%) came from hedge fund short selling. As I said above, both of these "uses" for borrowed gold made sense while the price was falling. They don't make much sense in an era where the price is rising like it has been since 2001.

So, of course, as you would expect, the mining operations have closed out most of their hedge books that were carried over from the 90s. Also, the CBs announced that they had agreed as a group not to expand their gold leasing operations beyond 1999. And any hedge funds that have been shorting gold for the last decade have surely gone out of business. So, most of the supply and demand for gold leasing is gone. The remaining demand (~25-30% of the leased gold back in 1999) is truly physical. It is the inventory leased to businesses that use gold as a raw material for fabrication (e.g. jewelry etc…).

If this is indeed the case, then what would "official support" look like today? Is physical gold still moving "in size" (but off market so as to not influence the price) with the help of the CBs like it was in the 90s? Well, since the first CBGA in 1999 it would appear that the CBs, along with the miners, have been unwinding a lot of what was wound up in the 90s. CB gold sales agreed under the CBGA declined until they all but disappeared in 2009, and in 2010 the CBs turned into net buyers of gold.

Part of my thesis in those last three posts is that official support may have reemerged specifically because of the financial crisis in 2008. If this is the case, and if this official support included CB gold sales, then we probably wouldn't expect to see the CBs turn from net sellers of gold in 2008 to net buyers in 2010. So, perhaps CB sales are not part of the "official support" occasionally helping to keep the paper and physical markets attached.

What about leasing? As I mentioned in my New Year's post, when the CBs renewed their CBGA for the second time in 2009 they forgot to include the line limiting gold leasing which was present in both of the prior agreements. Does this mean they expanded (or at least intended to expand) gold leasing to support the market? I don't know, but as I've already pointed out, it doesn't make much sense today even though it did in the 90s.

For one thing, expanding gold leasing operations tends to increase liquidity in the gold market which tends to drive down the price, yet as I said in my last post, the rising price of "gold" has been a major leg of support. Also, nearly 70% of the "users" of leased gold in the 90s no longer want it because now it's a losing proposition. So even if the CBs wanted to expand their leasing operations, the demand may not be there to get it done.

As I wrote in The Two-Legged Dog, a "long physical gold" position does not support the "gold" market (help keep paper gold attached or fixed to physical), instead it stresses and threatens it. Short physical and/or long paper gold are the only "positions" that support today's (quote-unquote) "gold" market:

"The position that lends the most support to today's "gold" market is "long paper gold and short physical gold." This was the position of Western gold bugs during the early 90s—trading in their physical for paper gold."

It was also the position of the CBs during the late 90s, selling physical and leasing. But today, or at least since 2009, the CBs in aggregate are apparently long physical. And an expansion of gold leasing not only doesn't make sense, it would tend to be counterproductive in an era where the rising price supports the market. In fact, what I was proposing in those last three posts was the occasional "official" levitation of the paper gold price at times when gravity would have otherwise prevailed.

Max De Niro asked:

"How is it that the ECB supports the paper gold market? Do they buy COMEX contracts, LBMA unallocated? Where would this show up on their balance sheet?"

Could there be another way? I don't know, so let's discuss it. And to kick off the discussion, I'll leave you with a few emails from my FOREX market insider. In the past I have called him FOREX trader lady or something to that extent. But from here on out we'll just call him FOREX Trader:

FOFOA,

This caught my eye in your latest article. The snippet from the old CBGA that was missing from the latest one in 2009:

"4. The signatories to this agreement have agreed not to expand their gold leasings and their use of gold futures and options over this period."

Recall the earlier discussion about which instruments were used to hedge nominal exposure to the price of gold?

There is your answer.

"Gold futures and options" has a very broad definition. I would guess that this allows them to operate with impunity on all the major electronic gold exchanges in the world.

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FOFOA,

This is what long paper short phys looks like on the spread. Thought you might be interested in the chart. This is a "monthly" of gold continuous front month futures contract minus spot gold price.

Theoretically this value should be synthetically very close to Gold lease rates "sell it now, buy it back in a month".



I thought it was interesting that the anomalies in this chart which resemble backwardation showed up in 2008 (and also today!) but not in 1999 or 2001. However, the 2008 anomaly seemed too early in the year to be October or November, where I thought it should be, so I asked him about it.

Sorry FOFOA,

Actually I think there is a problem with the X axis due to the nature of combining different futures contracts to make up the spread chart (i.e. front month is only front month until it isn't then another futures contract must be substituted and concatenated appropriately). So it may well have been later in the year. If I zoom in on 2008 specifically with a "daily nearest" rather than "daily continuation" it looks like this:



I told him that last chart made it even more interesting, and that I might use these charts in a post.

FOFOA,

If you are going to use them in a post, here is also the monthly nearest instead of monthly continuation. I provide the different ones because I can't really make a guarantee about the quality of the data.



From my personal experience of trading in Sep/Oct/Nov 2008: shit was fucked up. All markets I traded were the least efficient I've ever seen them. The contango on oil was so retard huge that JP Morgan was filling up tankers and storing for delivery later in the year. Here are just a few examples:









Thank you, FOREX Trader! My thesis is that today's (quote-unquote) "gold" market is somehow different from everything else. It is like the linchpin holding the wheels on a very old bus. It alone can bring the whole thing down if its legs fail. Very few understand this, and it's not even important if they do. It simply is.

The big question now is… does paper gold still have legs?

Sincerely,
FOFOA

[1] Gold Derivatives: The Market View 2000 – WGC with Jessica Cross, Virtual Metals Research & Consulting Ltd, London/Johannesburg
[2] Gold Derivatives: The Market Impact 2001 – WGC with Anthony Neuberger, Associate Professor of Finance, London Business School