The big feature of last week's decline in the gold price has been the lending of gold into the market. Commercial banks could have been doing it, but there is evidence in the past that central banks have leased gold to cap the gold price and bring it down. The gold price declines were so rapid and extensive that some investors theorized that central banks, including the Federal Reserve, were actively selling gold. The talk is that Commercial banks were unable to get the dollar liquidity they needed, leasing gold under their wings to facilitate these loans at lower interest rates. After the massive swap arrangements made between the U.S. Fed and the E.C.B., many felt that the problems of dollar liquidity had been overcome; however, by the extensive leasing of gold, this does not appear true.

Last year, we saw over 500 tonnes of gold for dollar swaps instituted by the Bank for International Settlements, then reversed as the swaps were completed. In light of central bank and Commercial bank lack of transparency on their gold dealings, the possibilities are worth contemplating by gold investors, because we must discern whether we're seeing distress selling as banks flail for survival, or if European central banks are attempting to hold back the gold price to stop it highlighting the parlous state of the world's leading currencies. We now speculate...

If gold is being leased, how can it make the gold price fall?

How could such lending result in the gold price falling? After all, the gold must at some point be returned to the lessor. What happens when gold is leased is that a Central, Bullion, or Commercial bank will loan gold to an entity that would sell that gold into the market for dollars.

Gold Leasing from 1985

This happened on a grand scale after 1985 when a host of central banks loaned gold primarily to gold producers -who would finance future gold production with the dollar proceeds ensuring they would have the gold to return to the lessors--knowing that their gold would be sold and knowing they would ensure that gold supplies to the open market would knock the gold price down from $850 to much lower levels. They were successful in these moves, taking the gold price to around $275.

But today, only a very small amount of gold production is financed this way. The easily mined, large gold deposits were fully developed last century, leaving only smaller deposits available for mining. These cannot suddenly be turned on, so gold borrowers are few and far between in the in the mining industry. Therefore, who would want to borrow gold? Would gold manufacturers?

Unlikely, because they would want to sell the gold and not return it. So whoever borrowed the gold outside gold producers would have a position: long dollars and short gold. Only someone who knew the gold price would fall (they would need facts to convince them that this was a low risk situation) or they would face a high risk, when it came to returning the gold. If the gold price rose they would find themselves in the same position as the gold producers were in when the gold price turned back up. When gold producers saw the gold price stop falling and turn back up, they were caught 'short'. So many gold producers eventually lost on their "hedged" positions. In fact, around 3,000 tonnes of gold was "de-hedged" over time, and there are only small hedged positions left in the market. What they believed was a prudent situation, the gold executives found, was a 'short' position in a rising market -the worst position company directors, handling shareholder's funds, could be in.

The big difference from now on is that there are few gold producers that would entertain borrowing gold today, no matter how cheap it could be. So who would want to go long of dollars and short of gold in these markets with prices moving fast and furiously both ways to the extent that interest rate differentials become insignificant?

Who is Leasing?

It could be European central banks, particularly if they knew for sure they would eventually get their gold back (as we mentioned earlier, provided swap arrangements for major banks). Within the year, the swaps were unwound. The banks knew the B.I.S. would not sell gold and hope to buy it back at the end of the swap, so a swap arrangement such as these would not carry a price risk because the Bank of International Settlements would not have 'played the market' but simply held the gold until the swap matured.

Some may say that it was gold lending by European commercial banks, but who would borrow from them just for the interest differential, while carrying the risk of price movements? Yes, it's true that the persistently negative gold lease rates provide an opportunity, but what a gamble with gold prices moving 3% with ease, in just a day. Yes, gold leases are at their lowest levels since 1998, but is this really sufficient an incentive?

Is gold being sold by Central Banks?

Market News International reported that the Bank for International Settlements, the Bank of England, and the Federal Reserve have been "good sellers of gold." There have not been any official denials of official selling.

Could it in fact be the Fed? Unlike most central banks, the Fed does not have access to U.S. gold reserves, which are held by the Treasury and can be sold only on the instructions of the Treasury secretary.

Could it be European central banks? They have a 'Central Bank Gold Agreement' in place with an annual 'ceiling' of 400 tonnes, so they have the ability to do so. The problem is that the E.C.B. publishes, on a weekly basis, the amount of gold sold within the Eurosystem. The only amount sold in the last year has been under 10 tonnes and primarily for coin production. So unless it has been sold in the last week, we would know. No meaningful sales have taken place in the last year from Eurosystem banks.

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