Gold & Silver Leasing

Gold and Silver “Leasing” Examined

Tom Szabo September 17, 2007 www.silveraxis.com I recently made some controversial and incorrect statements about metal “leasing” as part of my “Today in Silver” commentary at www.silveraxis.com. The following is an attempt to correct some of the errors as well as to provide more background information to demonstrate that the overall message wasn’t as crazy as it might sound. First, I would like to go back to the very beginning. Before lending or "leasing" of gold became common in the 1990's, there were gold swaps. A gold swap is simply an exchange of gold for a currency such as U.S. dollars under a legal contract that requires the transaction to be reversed at a fixed future date. For example, assume that Bank A, a central bank that owns gold bullion but is desperately in need of cash to provide liquidity to its banking system, were to arrange the following transaction with Bank B, another bank with "extra" cash: On January 1, Bank A delivers 100 tons of gold to Bank B in exchange for US$1.6 billion. So far, this looks like a sale of 100 tons of gold, but the important difference is that Bank A wishes to have this gold returned at a later date. If Bank A simply sold the gold and bought it back in the future, there is a risk that gold prices will be much higher and thus Bank A will not be able to afford to repurchase the gold. The transaction with Bank B, on the other hand, guarantees that the 100 tons of gold can be repurchased by Bank A at a fixed U.S. dollar amount. That is what makes this a "swap" instead of a "sale". In this example, let's assume the maturity date of this "gold swap" for U.S. dollars is in 6 months. Thus, on July 1, Bank B would deliver 100 tons of gold to Bank A in exchange for US$1.6 billion. Now the intervening question is, are both sides in this transaction happy to simply return the same amount of gold and cash to each other, or should one side or the other be compensated? Well, to answer that, let's...