Richard, good news, in that you and Bill Murphy and the rest of those who
have put in personal time and money into GATA can now feel with pride in
knowing that all who are short gold think gata is a bad 4 letter word.
A day will arrive when Bill Murphy will mail you a first class round trip
air ticket to the state of Texas, put you up in the best hotel and treat
you to aged steak + lobster dinner. At the end of the meal you will be
presented with a plaque that identifies you as a 4 star GATA General,
that was active in the combat zone of the gata war.
For other readers of this post: If the following 6 lines of text do not
create a desire to continue reading on, then you is on wrong thread.
The term "[gold]lease" is a misnomer, confusing the basic difference between
banking on the one hand and bailments and leases on the other...
...leased gold does not stay in the possession of the lessor.
...message of today's high gold lease rates ... central banks no longer
stand ready to lease gold in increasing quantities... and are instead
focusing on the problem of recovering their gold ... for Y2K and other...
Subj: Reginald H. Howe Serves Powerful Gold Market Commentary
Date: 9/22/99 12:37:52 PM EST
From: LePatron@LeMetropoleCafe.com
To: dougak
"Bank of England's Gold Sales: To Rescue the Fed?"
"Gold Leasing by Central Banks: Reaching the Limits"
The Dos Passos Table
Discussion du Jour: Guest Speaker
Bank of England's Gold Sales: To Rescue the Fed?
By Reginald H. Howe
www.goldensextant.com
September 20, 1999
Here is what seems clear about the Bank of England's gold sales:
1) The stated reason -- to adjust the composition of the bank's foreign
exchange reserves -- makes no sense.
2) The decision was made at the highest political levels, apparently
against the wishes of the bank's senior officers.
What can possibly explain and reconcile these two facts?
... people with serious credentials in the gold business have
suggested that although the Federal Reserve claims not to lease gold, it
may write (sell) call options that are used by bullion banks to hedge
their gold-leasing activities. If this assertion is correct (something I
have no way of knowing), it is possible that not only was the Fed
surprised by the strength of the gold price last May but also that it
was caught short with a lot of call options outstanding at around $300
per ounce. Were this the case, ... not hard to imagine a call for help
going out directly to the British prime minister. In particular,
depending on the maturity schedule of the options, holding gold in check
for just another few months could make a huge difference.
Of course if the Fed were writing call options, one effect --
intentional or not -- would be to stimulate gold leasing. So turning off
the option spigot would also cause the bullion banks to rein in their
activities, driving gold lease rates sharply higher. Indeed, at this
point it would be in the interest of the Fed, the Bank of England, the
other central banks, and the bullion banks all to cooperate to keep a
lid on the gold price long enough to permit an orderly reduction in net
gold derivatives.
Gold Leasing by Central Banks: Reaching the Limits
By Reginald H. Howe
www.goldensextant.com
September 16, 1999
Gold lease rates are soaring. What is going on? ...
The original purpose of central banks was to ...
Fast forward to late 1995. My contention that the central banks decided
to mobilize their gold as necessary in support of an effort to prevent a
complete financial and banking collapse in Japan is really no more than
an educated guess -- a deduction made after the fact on the evidence
available. It rests on my view that nations, no matter what officials
may say, do not part with gold absent very good reason, usually touching
issues of national survival or monetary sovereignty. The claim that a
government is selling gold merely to adjust the composition or yield of
its foreign exchange reserves strikes me as deeply suspect. The Dutch
and Belgian sales are far better understood as measures taken in
preparation for the Euro. My guess is that Canadian sales were not
unrelated to the Quebec issue, but that is a subject for another time.
The Bank of England's current sales are quite simply inexplicable on
this ground. And in time, if the proposed Swiss sales ever do occur, we
will probably learn that they involved some sort of calculation or quid
pro quo having to do with the protection of Swiss banking or
Switzerland's uniquely independent status within an integrated Europe...
By 1997, with the amount of gold reserves on lease having risen sharply
since 1995, two events suggest the first signs of central bank alarm.
First, the London Bullion Market Association (LBMA) disclosed for the
first time ever the volume of its gold trading activities and promised
to release average daily clearance figures every month in the interest
of greater market transparency. Second, the Federal Reserve commissioned
and made public an internal study on government gold policies.
... the over-the-counter London gold market dwarfs the public gold
markets in New York or Tokyo. More importantly, it is where most
transactions that involve gold leased from central banks are conducted.
Not surprisingly, therefore, the LBMA's disclosure received prominent
attention in the BIS's 67th annual report released in June 1997. There,
as part of an extended discussion of gold leasing (pp. 95-96; see my
earlier essay), the BIS noted that the amount of daily gold turnover in
London "rivals that of London trading of sterling against the Deutsche
mark." It added: "According to a Bank of England survey, most of the
trading was spot -- both physical and book entry -- with a significant
forward market and an active option market." Exactly why in January 1997
the LBMA broke with a tradition of secrecy going back hundreds of years
has never been fully explained. My opinion: the central bankers were
demanding a better picture of what was happening with their leased gold.
The Fed study can be read at
www.federalreserve.gov/pubs/ifdp/1997/582/ifdp582.pdf
... A startling feature of the presentation is the treatment of gold
to be mined as part of the available gold stock...
... if governments lent out all their gold but wanted to keep open the
possibility of using it in a crisis, they would have to structure their
loan contracts so that they could get their gold back immediately...
This study appears more an effort to rationalize a policy after the fact
than to develop a new, well- thought out one. It is the sort of memo a
bureaucrat might wave in explanation of a failed policy, but it could
hardly persuade a smart central banker to adopt the policy in the first
place. Why ? The authors fail to appreciate what central bankers know too
well: leased gold does not stay in the possession of the lessor.
The term "lease" is a misnomer, confusing the basic difference between
banking on the one hand and bailments and leases on the other. A bank
deposit of currency or gold creates a liability for repayment in
currency or gold, but the money actually deposited passes to the bank
for use in its business as it sees fit. The depositor necessarily
becomes a creditor of the bank. A bailment creates an obligation to
return the item bailed and gives no right to use it. A lease creates an
obligation to surrender the item leased at the end of the lease term,
during which period the lessor has the right to use but not to convert
or sell the leased property. A lessor does not become a creditor of the
lessee except as he may agree to accept rent in arrears. A gold loan by
a central bank is a deposit in a bullion bank, not a lease in the
ordinary sense of that word. The gold "leased" is effectively put out
for immediate sale into the physical market, where ultimately the gold
for repayment will have to be purchased...
... gold leasing is not leasing at all; it is banking...
The great irony of gold banking as practiced today is that central banks
are the principal depositors. Like private depositors before the era of
central banking, they must protect themselves.
By 1998, with net gold derivatives rising in step with the increased leasing
of gold by central banks, concern about the risks involved were rising too...
... The real question, however, is to what extent and at what risk central
banks "stand ready to lease gold," whether into rising prices or ...
Because accounting for leased gold varies by country, it is virtually
impossible to tell from official statistics how much government gold is
out on lease. What is known is that some governments withdraw gold from
the lease market near year-end to improve the risk profile of their
balance sheets. What is also clear is that at a daily rate of 1000 tons,
the LBMA's annual turnover is around 250,000 tons, or almost eight times
total official reserves.
After excluding from world reserves the United States and the
international financial institutions (BIS, IMF and ECB), there are some
20,000 tons theoretically available for lease. Reasonable current
estimates of the net short position in gold derivatives run from under
5000 to over 10,000 tons, implying that about this same amount is out on
lease from the central banks. Why ? Because, subject to the caveat
discussed in the next paragraph, it is the destiny of such leased gold
to be sold at spot into the physical market, creating a short position
of equal amount. This position may be hedged many times over, but it
remains a net short position until the gold is repurchased and returned
to the central bank that deposited it.
... in this event the bullion banks' rate of return would also be
less. On the other hand, if the bullion banks are not retaining
significant physical reserves (as I rather suspect), the risk profile of
the central bank gold out on lease is increased, and at a time when
general financial conditions are far from ordinary. Adding to the risk,
the central banks by their own leasing have driven gold prices to
bargain levels that have stimulated unprecedented physical demand,
accelerating the withdrawal of physical gold from the reaches of western
bullion bankers into India, other parts of Asia and the Middle East.
Finally, now pressing in on the central banks is a real wild card --
Y2K, a subject on which the BIS has issued several far from reassuring
reports. (See www.bis.org/ongoing/index.htm).
By any historical or common-sense measure, and particularly under
current circumstances, a net short gold derivatives position of anything
like 10,000 metric tons is pushing the limits of any reasonable
assessment of central bank tolerance for risk. To me at least, the
message of today's high gold lease rates is that central banks no longer
"stand ready to lease gold in increasing quantities" and are instead
focusing on the problem of recovering their gold in preparation for Y2K
and whatever other crises may lie directly ahead.
Expect them to issue reassuring statements; don't expect them them to
part with a lot more gold. No central banker wants to be remembered in
history for losing his nation's gold, or for giving it away.
Bill Murphy, Le Patron, Le Metropole Cafe
lemetropolecafe.com
lepatron@lemetropolecafe.com with questions or comments about the cafe.
Copyright 1999 Le Metropole Cafe
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