Sprott Update: "Central Banks, Bullion Banks and the Physical Gold Market Conundrum"

Tue, Jul 16, 2013 - 3:50pm

Released earlier today, the latest from Eric Sprott and Etienne Bordeleau at Sprott Asset Management is required reading.

This latest piece from Sprott is extraordinarily important. It details gold demand as well as Western central bank supply, leasing and manipulation. All the while, it puts into simple and understandable terms the current conundrum of mismatched leases that experts like Andrew Maguire are closely monitoring.

Please take the time to read this article today. Then, take the time to read it again. Maybe even print it out and keep it for posterity.


Central Banks, Bullion Banks and the Physical Gold Market Conundrum,

by Eric Sprott and Etienne Bordeleau

The recent decline in gold prices and the drain from physical ETFs have been interpreted by the media as signaling the end of the gold bull market. However, our analysis of the supply and demand dynamics underlying the gold market does not support this thesis.

For example, Non-Western Central Banks have been increasing their holdings of gold at a very rapid pace, going from 6,300 tonnes in Q1 2009 to more than 8,200 tonnes at the end of Q1 2013 (Figure 1a) while physical inventories are declining (Figure 1b) (or being raided, as we argued in the May 2013 Markets at a Glance)1 and physical demand from large (Figure 1c) and small (Figure 1d) scale buyers remains solid.

Source: World Gold Council, Bloomberg, Hong Kong Census and Statistics Department
Average premium calculated as the average premium for the following 1oz. coins, as reported by the Certified Coin Exchange (CCEX): American Eagle, Maple Leaf, Krugerrand, Philharmonic, Panda, Isle of Man and Kangaroo.

In previous articles we have argued that Western Central Banks have been filling the supply gap to satisfy the demand for physical gold.2 As shown in Figure 1a above, the official amount of gold held in the Western Central Banks and international institutions like the IMF has been steadily declining since 2000, only to stabilize at around 23,500 tonnes since 2008. Officially, this gold has primarily been sold by continental European Central Banks under what is known as the “Central Bank Gold Agreements” (CBGA) (also known as the Washington Agreement on Gold).3 Under this agreement (which expires after five years and has been repeatedly renewed since 1999), the “undersigned institutions will not enter the market as sellers, with the exception of “already decided sales” and “The signatories to this agreement have agreed not to expand their gold leasings and their use of gold futures and options over this period”. Sales under the CBGA are shown in Figure 2 below.

Source: World Gold Council4

The two points referenced above are particularly interesting because gold leasing (or swaps) has been the primary instrument used by central banks and bullion dealers to suppress the price of gold over time (Alan Greenspan testified, on 24 July 1998, to the House of Representatives that “central banks stand ready to lease gold in increasing quantities should the price rise”).5

It is important to remember that bullion banks (members of the London Bullion Market Association, or LBMA) hold gold in their vaults for their clients.6 Most of those clients, according to the LBMA, deposit their gold (or purchase gold) through an LBMA bank, for example ScotiaMocatta, in what is called an unallocated account. “This is an account where specific bars are not set aside and the customer has a general entitlement to the metal. It is the most convenient, cheapest and most commonly used method of holding metal.”7 However, what the LBMA doesn’t say is that, just like regular fractional banking, the bullion bank does not need to keep the whole value of the gold deposit in gold, but only keeps a fraction of it in its vaults, hoping that not all depositors will request their gold at once. This creates a potential shortage of physical (and an increasing supply of paper) gold and is one reason why bullion banks sometimes need to lease gold from central banks. Leasing gold is analogous to a swap or a collateralized loan, where a Central Bank gets cash in exchange for gold as collateral, and pays an interest rate on the cash loan.

The gold leasing mechanism works in the following way (also shown in Schema 1 below):8

A Central Bank leases its gold to a bullion bank for a pre-specified period (say 1 month). In exchange, the Central Bank receives cash for the value of the gold and has to pay the Gold Forward Offered Rates (GOFO) to the bullion bank. Then, the Central Bank lends the cash on the market and receives LIBOR for 1 month, with net proceeds of LIBOR minus the GOFO, which is called the lease rate. If the lease rate is positive (and it usually is), then it is profitable for the Central Bank to lease its gold. A high lease rate increases the incentive for Central Banks to lease their gold.

The bullion bank, once it receives the gold from the Central Bank, sells it on the gold spot market and collects the cash (depressing the price in the process by increasing supply in the market). For the bullion bank, this transaction is cash flow neutral and pays a carry (the GOFO rate) (the bullion bank can also buy the gold forward one month to make this a risk free transaction, or hope the price of gold stays constant or declines when it’s time to buy it back). Thus, the GOFO rate is a measure of “how much the bullion bank desires physical gold”. If it is small (relative to LIBOR, which implies a large lease rate), the bullion bank wants gold. If it becomes negative, then it means the bullion bank is ready to pay (negative carry) the Central Bank for the privilege to lease its gold (presumably to deliver physical gold to clients that redeem physical gold from their unallocated accounts).

In theory, at the end of the month, the bullion bank buys the gold back from the market and gives it back to the Central Bank. If the bullion bank repurchases the gold from the market, there is no net effect on overall gold supply. We say in theory because, as highlighted above, the language used in the CBGA hints at something else.

It is our hypothesis that, in practice, the bullion banks do not purchase the gold back in the market at the end of the lease to give it back to the Central Banks. Instead, they only roll the transaction over with the Central Bank, resulting in gold IOUs (paper gold, referred to as “gold swapped or on loan” under Central Bank accounting jargon, in other words, a claim on gold that someone else holds) instead of real bullion in the Central Bank’s vaults. This can be seen in Figure 3 below. There is a clear negative relationship between the amount of gold leaving the vaults of the New York Federal Reserve Bank (other Central Bank’s official gold reserves) and the lease rate (how much carry a Central Bank owns by leasing out its gold). To us, this is a clear indication that Central Banks have been leasing out their physical gold against IOUs from their bullion bank partners.

Source: Federal Reserve Bulletin, Foreign Official Assets Held at Federal Reserve Banks, Earmarked Gold & LBMA. The 1-month lease rate is shown as an annual average.

Also, oddly enough, it seems from Figure 3 that the gold bull market started at about the same time (mid-2001/early 2002) as Central Banks and Bullion Banks stopped flooding the market with leased gold.

Another interesting observation is that the timing of official sales by European Central Banks and the International Monetary Fund (IMF) (Figure 2) do not really correspond with the outflows from the NY Fed’s vault (where most of the world’s Central Banks’ gold ex-US is stored; about 30% by our calculations). This is where the “already decided sales” concept referred to earlier comes into play.9

According to the IMF, they disposed of 403.3 tonnes of gold between 2009 and December 2010.10 However, the net outflows of gold out of the NY Fed’s vault were zero for those two years (and the NY Fed is the main vault for the IMF).11 If this rather large quantity of gold did not come from another vault, then it is plausible that it came out of the NY Fed’s vault, which experienced a net drawdown of 408 tonnes in 2007-2008, a full two years ahead of “official schedule”. Given this inconsistency, it is reasonable to believe that the IMF leased its gold reserves (in the manner explained above) to tame the gold market and rescue the bullion dealers, which probably got a lot of physical gold redemption requests they couldn’t meet during the financial crisis. Then, later on, they “sold” their paper gold to the dealers to net the IOUs and settled in cash.

A similar observation can be made of the European Central Banks’ CGBAs, which all happened well after all the gold outflows from the NY Fed’s vaults.

We are of the opinion that this is what an “already decided” sale is: a Central Bank leases gold to a bullion dealer, that dealer sells the gold (or delivers it to a client) but never pays back the Central Bank its physical gold. Then later on, to balance things out, the Central Banks declare official “sales” of gold, but all that changes hands at that point is paper gold and cash, the real gold is long gone.

Lessons for the current market

It is important to remember that the bullion dealers are the same banks that are deemed too big to fail by their respective governments. Thus, it is very unlikely that Central Banks would abstain from intervening à la Greenspan in order to save their bullion bank partners from a “bullion run” (analogous to a bank run). On the contrary, if the bullion dealers get in trouble because their reserves of physical gold are too small to match redemptions of physical (anecdotes) and risk a bullion run, Central Banks will use their firepower and “stand ready to lease gold in increasing quantities should the price rise” (Greenspan, 1998).

The thing is, it might not be that simple anymore… Since the beginning of the financial crisis, we have seen unprecedented demand for physical gold (see Figure 1a-d above) while at the same time, gold miners are shutting down mines and Central Banks have been relatively quiet in terms of official gold sales (Figure 2) (depressing supply). In fact, the announcement by the German Bundesbank (the second largest gold reserve in the world according to IMF data) that they would repatriate their gold from the NY Fed’s vaults can be seen as a sign that European banks are no longer as keen to lease (or swap) out their gold.12 Other very detailed documents released at the same time show that since 2008, the Bundesbank has not made use of gold leases or swaps.13 To us, this signals that Central Banks are less and less willing to participate in the gold leasing scheme.

Still, the price of gold has experienced a large decline over the past few months, only slightly recovering over the past 2 weeks or so. Given the strong physical demand, we think that this decline was engineered by a bullion bank that flooded the COMEX (paper market), only to then redeem physical gold from the various available sources at depressed prices (i.e. ETFs, see our discussion of this topic in the May 2013 Markets at a Glance). To further support our price manipulation hypothesis, we overlay the 1-month GOFO rate with days where the gold price suffered significant declines (more than 3%) in Figure 4. Unless it is the actual price drop that sparks all this increased demand, it seems counterintuitive that the gold price would decline precipitously before large declines in the GOFO rate, which implies increased demand for physical gold from bullion dealers.

It now seems that bullion banks are in desperate need of bullion, as evidenced by the increasingly negative GOFO rates we are seeing (Figure 4 below). Remember that a negative GOFO rate signifies that the bullion banks are ready to pay holders of physical to lease their gold, in this case for a month. Historically, negative GOFO rates have happened in very few occurrences. The last one was in November 2008 at the height of the financial crisis and after which gold rose 156% from through to peak. Before that, we saw negative GOFO rates in March of 2001 (about the start of the bull market) and September of 1999 (announcement of the first CBGA).

In our view, the bullion banks’ fractional gold deposit system is testing its limits. Too much paper gold exists for the amount of physical gold available. Demand from emerging markets, who do not settle for paper gold, has perturbed the status quo. Thus, our recommendation to investors is the following: empty unallocated gold accounts and redeem your gold in physical form (while you still can), invest in allocated, physically backed products (like the Sprott Physical Bullion Trusts) or in those that have access to physical gold in the ground (gold miners).

1 https://www.sprott.com/markets-at-a-glance/redemptions-in-the-gld-are,-o...
2 https://www.sprott.com/markets-at-a-glance/do-western-central-banks-have...
3 See https://www.gold.org/government_affairs/reserve_asset_management/central... for a discussion of the history of the Central Bank Gold Agreements (CBGA).
4 Signatories to the third Central Bank Gold Agreement which commenced in September 2009. The signatories include: ECB, Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Slovakia, Slovenia, Spain, Sweden, Switzerland. Estonia became a signatory upon joining the Euro in January 2011.
5 https://www.federalreserve.gov/boarddocs/testimony/1998/19980724.htm
6 The bullion dealers are: Bank of Nova Scotia–ScotiaMocatta, Barclays Bank Plc, Deutsche Bank AG, HSBC Bank USA, NA and Société Générale
7 https://www.lbma.org.uk/pages/index.cfm?page_id=19&title=bullion_acc...
8 For more on this topic, see “On the Lease Rate, Convenience Yield and Speculative Effects in the Gold Futures Market”, Swiss Finance Institute Research Paper Series 09-07. ,https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1365180
9 We would like to acknowledge the use of this blog as a source of inspiration: https://victorthecleaner.wordpress.com/
10 https://www.imf.org/external/about/gold.htm
11 https://info.goldavenue.com/info_site/in_mark/in_offgold_frny.htm
12 https://www.bloomberg.com/news/2013-01-16/bundesbank-to-repatriate-674-t...
13 https://www.bundesbank.de/Redaktion/DE/Downloads/Bundesbank/Wissenswert/...

About the Author

turd [at] tfmetalsreport [dot] com ()


Jul 23, 2013 - 7:16am

Dr J - on microclimates

You have to watch the soil also, not just the rainfall.

Conifers are a bit notorious for making the soil perfect for only conifers. Try to grow anything in pine duff. Looks pretty good but only little pine trees like it.

Jul 17, 2013 - 5:07pm

re Open Winner

That is exactly how I don't look after I swing a golf club. It is like his eyes are going to make the ball go where they tell it to.

Signs I don't need:

Jul 17, 2013 - 2:41pm
Jul 17, 2013 - 12:14pm


Blew that 19.60 support level completely out of the water.

So, anyone have a pal with a spare 500K$ laying around to get JPM out of the bullion space? Just Asking

There are only two positions that I'm interested in, to come out of retirement, JPM hit man, and US President 2016, both jobs are easy to do, seemingly, but both require support from others. July 2013 to November 2013 stand ready to take down JPM in the bullion Space July 2013 to November 2014 Teach politics by Blog November 2014 to November 2015 campaign for the Presidency. Of course taking down JPM in the bullion space as a litigator, or eliminating the National Debt as President are not easily believed by nearly all, but I know how, but need support, so, offering the services at this time. The word is out on my blog Totalitarian Democracy, TFMetalsreport and LemetropoleCafe and by Emails and Twitter to various groups, and that is the best I can do presently, without pestering anyone. https://totalcontrol.blogtownhall.com/
Katie Rose
Jul 17, 2013 - 12:14pm

You need to read this.....

Dyna mo hum posted this link on page 1 of this thread. It was mostly ignored. I believe it is a trial run by the EE. It is a chilling thought that the government wants to know everything about our stacking practices.

If I lived in Connecticut, I would put my house on the market immediately and leave the state before they made it illegal to do so.

Connecticut: “No Guns, No Gold”
Written by Gary North on April 26, 2013

You probably know about the gun control bill that was voted into law this month. Gun manufacturers are threatening to move out of the state. The story is here.

The state is now about to shut down all coin stores. A bill to require complete record-keeping on all sales, including photos of every coin sold, and recording the ID of every buyer and seller, is about to be passed into law. The cost of complying will shut down the stores. Read about it here.


To require precious metals or stones dealers to provide a periodic statement of transactions in an electronic format to the local licensing authority and retain any goods purchased for at least ten days, and to make the requirements applicable to precious metals or stones dealers similar to those applicable to secondhand dealers.

Introduced by: Public Safety and Security Committee

You may recall that the terror of the French Revolution was run by the Committee on Public Safety.

How bad is this proposed bill? Here are the details, from the state’s website.

Property Description. Under the bill, the record’s property description must include:

1. all distinguishing marks, engravings, and etchings;

2. names of any kind, including brand and model;

3. model and serial numbers;

4. affiliation with any institution or organization;

5. dates;

6. initials;

7. color;

8. vintage; and

9. image represented.

Read more:


Jul 17, 2013 - 11:51am


Clinical researcher I. M. Long has defined a new disease, Bullion Tanking Fatigue Disorder or BTFD for short.

Classic cases exhibit 3 or more of these behaviors:

1. Anxiety whenever someone says that gold is going to go lower in price. Often manifested in calling the person that says it an idiot and vowing to never watch, listen, or read the blog of that person again.

2. Listening to and reading articles by odd named commentators like "Turd", "Golden Jackass", and "Santa."

3. Frustration that family and friends do not share this disease. Can lead to alienation, especially from friends and family that bought gold and silver on their advice in 2011.

4. Belief that things do not exist that they cannot see, like gold in the Fed's vault or in Ft. Knox.

5. Paranoia as exhibited by belief that PM markets are manipulated or at least more manipulated than other markets.

6. Extreme distrust of most everyone. This usually starts with the government then extends to all politicians, CFTC, bankers, and then to anyone saying gold is going down in price (see number 1 above).

Severe cases can be heard screaming "damn miners" while looking with disbelief at their computer screens.

Many patients also exhibit an interest in safes and diving equipment. Some also have an interest in cured pork products, but researchers have failed to find the link for this symptom.

At the present time there is no known cure. Symptoms do seem to improve when the patient rubs gold or silver coins. Reduction in time spent logged onto sites like kingworldnews has resulted in improvement for some patients. Many patients insist they do not have problem, it is everyone else (they refer to as sheep or sheeple) that has a problem. Time may be the only long term cure.

Jul 17, 2013 - 11:02am

I need a hot tub in my back yard

My wife and I are searching the local ads for a water cistern for sale that we can bury in the back yard. We seem to get sufficient rain here next to the mountain (a micro-climate) that storing rain water might be a sustainable strategy, even here in the dry west.

But, it just occurred to me that a hot tub on the back porch would be a most excellent prep item. I want to be fully prepped without attracting attention to my home from neighbors. We want to look like we live at the same standard, and deal withthe samle problems as everyone else. Don't stand out! The hot tub might just fit the bill. It stores water. You can use it to bathe without wasting water --just need to install a filter. While the water may not be fit for drinking, it could keep a greenhouse well watered while waiting for more rain. And I need not mention the sense of luxury and pleasure one could derive in the midst of a tough economic climate. I bet I could hide things behind the panels as well! We saw one on craigslist for free just before we moved. No reply from the poster. Alas. We will keep watching.

On micro-climates...

I had never heard of a micro climate before this year. In our town, there are literally neighborhoods that have milder temps in winter, more rainfall, and one is able to grow fruit trees. Other neighborhoods have more severe temps and only the hardy pine and cedar will grow. Still other neighborhoods just a few miles away receive insufficient rain for the tall trees to grow. A fellow Turdite mentioned to me that his region of the state (about an hour distant) has a water table only 15 feet deep below ground. Who would have known? In most of the rest of the state, the water table is hundreds to thousands of feet deep.

Food for thought...

Jul 17, 2013 - 11:00am

is it just me?

So Ben Berspankme says he may taper down the road and that makes the dollar soar???? what? Or am I seeing the wrong chart? Upside down world where the dollar goes up as Ben says he'll keep printing.

Visit the FAQ page to learn how to track your last read comment, add images, embed videos, tweets, and animated gifs, and more.

Jul 17, 2013 - 10:58am

The Bernank must have used

The Bernank must have used the "taper" word again, so down we go. Or was it front running the "taper" word?

Urban Roman
Jul 17, 2013 - 10:57am

Oh noes

It's the dreaded 'Turd Hat' formation.


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