Big Shift In Gold Fundamentals: Central Banks Not Rolling Forward Gold Leases

Here's an important quote from a 7/10/2008 Financial Times article: "central banks... are not rolling forward old leases after maturity." This is clearly shown as panic on the gold lease chart above. At a time when cash interest rates are being slashed around the world, gold and silver lease (interest) rates are exploding. Why, because central banks are afraid of counterparty risk. They dont trust commercial banks to return their gold or silver. Think about this, central banks are willing to give paper money away to anyone, anywhere, anytime at lower and lower prices but they are hoarding their gold and silver - doesnt this tell you what central banks consider real money?

Anyway back to the lease rates. To understand what this is about, one must understand the basics of central bank gold leasing. The Gold Antitrust Action Committee (GATA) is convinced (and I accept their claims), that the US Treasury and its allies, including the European central banks, have been suppressing the price of gold for about a decade by strategically selling their gold. They do this, GATA claims, to limit gold's ability to supplant their fiat (not backed by anything) currencies (US$, GBP, Euro) while they continually debase these currencies.

Whether you accept GATA's claims or not, the fact is that the supply of gold (as seen by those buying and selling gold) has been increased by two central bank actions:

(1) Direct gold sales. The amount to be sold was negotiated four years ago by a treaty known as the Washington Agreement which expired in September 2008.

(2) Gold leases to third parties (at extremely low interest rates). Those third parties then sold the gold and used the proceeds to invest in other vehicles where they expected higher returns. When such a gold lease matures it must either be rolled over, or the lessee must obtain (buy) the leased amount of gold and return it to the central bank.

With this in mind we can see the importance of the following two quotes from the above article:

(1) "Central banks have all but stopped lending gold to commercial and investment banks and other participants in the precious metals market" - this eliminates a significant fraction of supply seen by the gold markets. It also implies that central banks have changed their view of the significance of gold and will probably not continue to sell it as they have in the past (again eliminating a significant fraction of gold supply, roughly equivalent to 20% of annual mine production).

(2) "central banks... are not rolling forward old leases after maturity." - this means that as these leases mature, the lessees must buy gold to return it to the central banks. This creates a significant new form of demand for gold.

Together this is a significant increase in demand relative to supply equivalent to something like a 20 to 25% reduction in gold mine production. This should, according to economics 101 and with all things being otherwise equal, push the price of gold significantly higher. Its interesting to note that what happened to the price of lead (Pb), the heavy metal, when it took only a 3% reduction of supply in the form of a mine closing in 2007. The price of lead (Pb) rose more than 100% (from $.80/lb to around $1.80/lb). Its a natural to conclude that the price of gold, based on this larger change in demand / supply dynamics, will react even more substantially. We'll see.