Central Bank Gold Leasing

The salespeople of the gold investment industry publish a lot of bold claims about central bank activities in the gold market (for example, here) along the lines of “All central banks want to suppress the gold price.“, “The central banks have secretly leased and sold most of their gold.” The present article is an attempt to summarize the facts that we know and to offer a rather different interpretation.
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GLD – The Central Bank Of The Bullion Banks

The black curve (left scale) of the following chart shows the London pm gold fixing in U.S. dollars from 1 January 2006 to 30 April 2012. During the light-blue intervals which span about 35% of the entire period, the gold price increased at an annualized rate of 41.1%. During the remaining intervals, the price increased only at an annualized rate of 7.9%. The light-blue intervals are the result of a trading algorithm whose buy signals are indicated by the green dots and whose sell signals by the red dots.

GLD Inventory Strategy from 1 January 2006 to 30 April 2012

In this article, we explain how the signals can be computed from the variations of the inventory of the SPDR Gold Shares exchange traded trust (NYSEArca:GLD). We explain why the inventory adjustments can hardly be caused by price arbitrage between the GLD share price and the loco London spot price alone. We rather claim that bullion banks finance their inventory by lending it or selling it to GLD investors and that bullion banks manage their physical reserves by accessing the physical gold inside GLD.

The fact that a certain type of inventory adjustments has predictive power, supports the idea that large inventory changes are the result of active reserve management. This provides us with a unique window into the flow of physical gold that is usually obscured by the dominance of paper gold trading. A similar, but somewhat less robust result is shown for the iShares Silver Trust (NYSEArca:SLV).

WARNING (April 2013): This article uses the term buy signal in a technical sense. It does not mean that you ought to buy anything without understanding what you are doing. Notably, the rapid price increases after the buy signals have been absent since the fourth quarter 2012. Now you might dismiss the trading algorithm as a statistical fluctuation. Alternatively, you can wonder whether something might have changed.
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Backwardation in the Case of a Monetary Metal

Silver has been in backwardation at the LBMA according to the published SIFO (Silver Forward Offered Rates) since January 19, 2011. It has also been in backwardation at the COMEX (New York Commodity Exchange) since around February 7, 2011. Figure 1 shows the LBMA Silver Forward Offered Rate from November 22, 2010, to May 19, 2011.

LBMA Silver Forward Offered Rate (SIFO) 2010-2011

Figure 1: LBMA Silver Forward Offered Rate (SIFO) 2010-2011

 
I was dissatisfied with much of what has been written on this topic. This is an attempt of a better explanation.

Summary

I explain that silver should not be viewed as an industrial commodity that is consumed, but that one should rather view US$ and silver as a currency pair. If one takes this point of view, backwardation is not a market inefficiency due to a supply shortage, but rather indicates counterparty risk.

Update (27 February 2012): Backwardation is also possible if US$ deposits are subject to carrying charges or if nominal interest rates are negative, see Red Alert Update.

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