Byron King

Today I want to share something else — something remarkable — that’s happening within the gold markets…

The everyday charts don’t show it. Yes, the price of gold has fallen — that’s in the charts. But physical gold is still scarce. That is, it’s getting more difficult and more expensive to borrow gold. There’s not enough physical gold to meet the needs, and the rent is rising, so to speak.

What do I mean? A recent article in the Financial Times described a shortage of so-called “leased” gold. According to the Times, the cost of borrowing gold “has risen to the highest since the post-Lehman Bros. scramble for supplies as bullion markets adjust to a new era in which Western investor demand is less dominant.”

The numbers are small, but the trends are intriguing. The one-month gold leasing rate rose from 0.12% in early June to 0.3% in early July. That’s a 150% rate rise in one month! It’s the highest gold lease rate since 2009, although still well below the peaks of previous eras.

In 2008, during the stock market crash — when people sold anything that would attract a bid — one-month gold leasing rates rose as high as 2.7%. Further back in 1999, toward the end of the 1990s decade of golden doldrums, gold lease rates were an eye-popping 9.9%. Back then, it barely paid to lease gold… hold that thought.

A Strange Way to “Borrow” Something…

What’s going on? First, if you’re not familiar with the gold leasing market, there’s a good reason for that. You’re not supposed to know much about it. Gold leasing is a niche activity, and largely the preserve of a few big banks (Goldman Sachs, JP Morgan, etc.) and central banks. Gold leasing is virtually off-limits to retail investors.

Big banks “borrow” gold — it’s what it sounds like — from physical gold holders like… oh, gee… central banks. After that, things get shadowy. Still, let’s think of “borrowing” gold as kind of like renting a car. You get a nice, clean car with a full tank of gas. You drive away, and eventually the rental agency wants its car back.

With “leased” gold, the banks take the metal, but then they sell it to industrial users, or perhaps to investors who want physical delivery (unless you’re the University of Texas and want a billion dollars’ worth of the stuff). The idea is that, eventually, the gold borrower will obtain more gold from another source — let’s say a mine or gold refinery — and return gold that they borrowed from the central bank.

In practice, much of the “leased” gold goes out for terms of many months, if not years. Many of those gold “leases” have been extended multiple times, up to many years.

In that sense, the gold leasing model is as if you rented a car, drove off the lot and immediately sold it to somebody else. Then you paid yourself a big bonus (because you’re a banker, right?), invested the leftover cash in other things and kept the car rental agreement rolling over for years at a time. Eventually, someday perhaps, you or your successor might return a different car to the agency.

It’s bizarre, right? Yet that’s how this gold-leasing biz works. In many respects, it’s a subsidy from central banks to big banks (surprised?). It works — after a fashion — in a rising gold environment where everyone smiles, signs the papers and rolls over the contracts. But when the gold price falls? Or when the physical side dries up because… say… Asian buyers snap up gold contracts and then demand delivery?

Right now, there’s a case to be made that much of the world’s “leased” gold may be on “permanent loan,” if you get my drift. Think about it. Where will the gold borrowers ever get the yellow metal that they need to return to the lenders? Thus, gold lenders and borrowers keep rolling over the leases and moving “return” dates out into the future.

If you’re wondering, the gold-leasing business is likely another financial meltdown waiting to happen to any number of large banks when the lessees eventually cannot return the gold that they borrowed. For now, gold borrowers need cooperative lessors who are willing to roll over the gold loans far into the future. Meanwhile, the carrying cost is the above-noted rising gold lease interest rates.

Will Scarcity Sink Gold Leasing?

For the past few years, with increasing amounts of gold in investor hands (as with GLD, individual buyers and such), the gold-leasing biz has been fairly stable. Lease rates for gold found relatively low price points.

But recently with gold, many former buyers have turned into sellers — at least for “paper” gold. According to bankers engaged in gold leasing, the availability of physical gold in the lending market has tightened up. This supply squeeze has triggered the above-noted sharp rise in gold leasing rates.

Another way to look at it is that back in the 1990s, with low gold prices and not much volatility, the investment community didn’t foresee the price explosion that was about to occur. And recall those very high monthly lease rates for gold back in those more sober days.

Now, though, we have a dramatic shift in the gold market. Many investors have recently sold gold (“paper,” mostly) en masse, triggering a 30% collapse in gold prices since the start of the year.

Gold leasing markets spent nearly a decade getting used to ever-rising prices and relatively good supply availability from gold lenders or miners. Now, with falling gold prices, rising interest rates, Asian demand for physical metal and precarious mine output (recall the point about the gold price nearing the average cost per ounce), the gold leasing biz is about to get dicey.

If even one large gold borrower ever has to make good on a return — as if the car agency calls and demands its vehicle back — expect a scramble for physical product, with a sharp upward price rally. Along the way, consider how tight physical supplies could trigger a bloodcurdling squeeze among funds with short positions in gold, potentially driving prices higher.

It’ll be a good time to own physical gold, which I hope you’ve been buying. And the mining shares could offer huge gains as Johnny-come-lately investors pile into a beaten-down sector. The big mining guys will do well. Some of the junior development plays could utterly soar.

Yes, it’s a very strange gold market. Nominal prices are down, but scarcity is up. Lease rates are up. Physical shortages are baked into the cake. Eventually, the markets will figure it all out.

Thanks for reading.

Byron W. King
Original article posted on Daily Resource Hunter

You May Also Like:


The True Value of Gold

Paul Van Eeden

When you boil it down, a "price" is simply a comparison between two different things. That's why "price" and "value" aren't always the same thing. In this interview, Paul van Eeden discusses gold, and explains why the price of gold is different from its value and why he's not at all surprised by its recent performance. Read on...

Byron King

Byron King is the editor of Outstanding Investments, Byron King's Military-Tech Alert, and Real Wealth Trader. He is a Harvard-trained geologist who has traveled to every U.S. state and territory and six of the seven continents. He has conducted site visits to mineral deposits in 26 countries and deep-water oil fields in five oceans. This provides him with a unique perspective on the myriad of investment opportunities in energy and mineral exploration. He has been interviewed by dozens of major print and broadcast media outlets including The Financial Times, The Guardian, The Washington Post, MSN Money, MarketWatch, Fox Business News, and PBS Newshour.

Recent Articles

Addison Wiggin
Health Care Costs: Still the Pig in the Federal Python

Addison Wiggin

Right now, health care makes up about 25% of the federal budget. A scary statistic to be sure... But here's an even scarier one: health care's portion of the federal budget doubles roughly every 20 years. Yikes! Addison Wiggin explains why this is and what needs to change to prevent health care from taking up half the federal budget. Read on...


Six Signs Your Government’s Too Big

Chris Campbell

Is your government too big? Find out in today’s Laissez Faire Today with six “red flags” to look out for. Chris Campbell covers everything from one ObamaCare whistleblower to the strange case of our new Ebola czar. Read on…


McDisaster: Fast Food Is Dying – Make a Killing From It…

Greg Guenthner

McDonalds stock is getting crushed right now. Shares have been in a tailspin since June. But it’s not just Mickey Dee’s. Coca Cola shares are in freefall, too. Bad news for them. But if you want to rake in a pile of easy money, it could be great news for you. See, Americans just aren’t choking down this junk like they used to. The fast food burger, fries and a Coke are just down payments on an early coronary - and Type II diabetes. And everyone’s finally gotten the message. So how can you play the trend? Greg Guenthner explains…


In the Year 2024

James Rickards

Panopticon goggles? Severe market panic in 2018? Gold confiscation by 2020? Jim Rickards' shocking thought-piece in the spirit of A Brave New World or 1984. Click to see how markets, economics, your money, gold, privacy, wealth building and more look a decade from now in the year 2024...


Our Ebola Stocks Could Double Overnight

Paul Mampilly

I believe we are in the midst of one of the greatest profit opportunities you’re ever going to see in your lifetime. Stop listening to what the government is telling you. Turn off CNN. Forget what you see on the news. And for God’s sake, forget about the market crashing. Right now, we are in the early innings of the greatest profit opportunities of the 21st century. A biotech boom that’s about to hit epic proportions thanks to Ebola. If I’m right, we are going to see Ebola in New York, Los Angeles, San Francisco and Miami. And when this happens, every single stock that has anything to do with Ebola is going to soar. Let me explain to you how I believe this huge Ebola bubble is going to unfold.