I was surprised to find that many silver and gold investors who had been buying the metals for many years still do not know what Metals Leasing is and why it is the single most bullish factor to own either Gold or Silver as 2009 begins.It is my opinion that the metals leasing program is about to unwind for both Gold and Silver and the price effect of this unwinding will be profound and instant.Silver stands as a much better candidate to Gold for reasons explained in this article, however gold will not be left out of the picture either.
Below is a simple, easy to read article on Silver Metals Leasing. In my opinion, metals leasing will play out differently for Gold than Silver, so this article focuses on the Silver aspect, given that it is consumed more and will, in my opinion, will surge much more than Gold as metals leasing unwinds.
Origins – The Bankers “Problem”
Large banks with huge stockpiles of Gold and Silver sitting in their vaults never earned any income from their bullion. After all, the metals intended function was to preserve wealth for the bank, not create it.Greed is a powerful force. Just “having” Gold and Silver wasn’t good enough for the major banks and they scratched their heads as to how they can bleed even more profit from their enterprises, in particular, how can they turn their Metal into money, without getting rid of their Metal!The big banks would never want to just sell their Gold and Silver reserves as it represents and backs their enterprise and is what instils faith in their organisation – but hey who says you can’t make some cash on the side, huh?
Some smart banker from the banking Cartels, who no doubt got a promotion after coming up with the idea said “What if we lease the metals?“Lease to the smaller banks for say, 1 or 2 percent per year on the value of the physical metal.This way we could earn more cash, while still keeping legal ownership over all our precious metal! Brilliant!
But why would other banks lease metal just to keep them in their vaults, I hear you ask? Good question… read on.
Crack Open Them Vaults!
Metals leasing was borne, and it was a huge success!The banking cartel opened their vaults and started delivering physical bullion to the smaller banks on lease contracts.And to answer your question from the previous paragraph – The smaller banks had no problem in paying 1-2% for the metals because they sold the metals into the open market and invested the cash into higher yielding assets (assets that paid more percentage points than what the metals were leased for in the first place).
A major windfall for both the banking cartel who started earning money for leasing their otherwise stagnate assets, and the smaller banks loved the few percentage points they made risk free. Everyone happy right?
Before I continue, lets examine the specifics of this.
Silver and Gold are considered fungible. This means that if I lend you 1kg of pure gold, regardless of what happens with that bar of gold, so long as you return ANY gold bar of equal weight, that is considered as good as the original one I lent. This is the only way metals leasing can work. No-one in their right mind would lease anything and then sell it into the open market if they had to get that exact same bar of metal back at the end of the lease.
By selling the metals from the big banks, there is the appearance of oversupply of silver and gold in the market. As will become evident later, this is a fake supply hitting the market, but the metals price depression is a real effect of this fake supply.
The banks who are leasing the Silver and Gold make guaranteed profit as the metals leasing cost (1-2%) is far below what they can make in the open market when they sell the bullion and invest in a 4-5% yielding asset (Government bonds, t-bills etc). When the metals lease expires, generally there is no reason to return the Metal (i.e. buy the metals back from the open market) – it makes more sense to roll the lease into another contract.
A Real Life Example
As a result of this leasing, the price of silver and gold are beaten down compared to where they should rightfully be.To see the effect of this leasing on the market, consider the following example.A Bank owns 500 houses in any given suburb. They then rent (lease) these houses out to tenants who, at the end of the contract promise to return the house or rollover into another rental contract.Now lets say that these 500 tenants decide to sell their rental houses, and invest the money made into other ventures (Yes, this is illegal for real-estate – but allowed for precious metals – go figure!).
What would 500 houses being sold in that suburb do to the price of real-estate in that area? It would fall through the floor. The other houses in the area would be devalued to a large degree. This would also force other sales in the area as investors see the price of real-estate falling and get out of the market – creating a domino effect of plummeting house prices.
This same effect of a price suppression is seen on the price of both Gold and Silver. Through leasing – there is only a fake supply of metals on the market (remember the actual owner doesn’t want to sell the metal, that’s the whole reason why they are just leasing it out in the first place).
Some call this manipulation of the markets. I agree, but it also creates an opportunity like never before – read on.
So back to leasing… the big banks making 1-2% on metals that were just sitting in their vault – they are happy. After all, the bullion being leased to the banks are recorded as assets of the bank as if it were still sitting in their vault – and at some stage will get them back (well, so they think!)The bullion and smaller banks are happy because they are making more money re-investing profits earned from the sale of the metal into the open market.Only the staunch silver investor is unhappy because he is seeing this fake supply of metals decimate his investment.Metals leasing is money in the bag for the banks for as long as the system is in place. But really, we all know that no-one gets a free ride in the long run – especially in the banking industry.Enron Style Accounting
But isn’t these sales of silver and gold diminishing supplies and as such – wouldn’t the price rally on such a force?Well, here is where it starts to get a little shifty. The big central banks consider their lease contracts sold to smaller banks “as good as Gold or Silver” since, legally, they can call the lease in at any time or the bank doing the leasing and return the metal at the end of the lease.The banks have dealt with paper and computer electrons for so long, they forget they are dealing with a tangible asset and no paper trade could ever get the physical metal back into their vaults!So the big banks, when reporting their assets, count physical silver AND silver that is under lease as 1 line item… that is, even if 90% of a banks silver is out on loan, its still appears on the books as sitting in the vault!But what if the Silver cannot be returned – period?
Show Me The Metal!
Here’s the gottchya point. The silver being leased, which is then sold, is gone and cannot be repaid. There is not enough silver above ground to account for the deficit on lease. It is estimated that a full 2 years supply of silver that is out “on loan” has been sold and used in our computers and electrical, our medical industry, our photography, our solar panels, our military equipment and a myriad of other products.You see, Silver (unlike gold) is not just horded for its intrinsic value – it is consumed – its gone baby.Now maybe the big banks didn’t realise just how much Silver would be used before starting to lease it out – or maybe they did but concluded that silver is in abundance and leasing makes sense (as was the case 3-4 decades ago).In 2009 however, there is no even 1 year supply of Silver above ground, yet there are 2 years supply of lease contracts needing to be returned. You do the math!
What’s the End-Game?
I’ve postured below how the end game may play out in Silver Metals Leasing. I cannot say it will play out the same for Gold, but it may. Here are the flags I think we’ll witness before Silver makes its mighty leap.Red Flag #1: The banks leasing the Silver will become concerned about hard inventory levels and the ability for repayment at some stage (its already too late however).Red Flag #2: In order to not create a run on Silver, they will gently increase the Silver lease rates over time as to not scare other banks into the realisation of the same problem they are witnessing. It’s important they do this relatively slowly… the last thing these lenders want is a run on Silver as it diminishes their chances of getting the physical back into the vault.Red Flag #3: As the lease rates increase, it doesn’t make sense to keep the monies earned from selling the Silver in the first place in the open market and lease contracts will not be rolled over.Red Flag #4: Metals will be bought back on market and delivered to the leasing banks.
Red Flag #5: As this starts to happen en masse, Comex and other Silver exchanges will default on delivery and at that time the cat is out of the bag and the Silver rush will ensue.
Lets look at what happened to the price of Nickel when Comex defaulted on that in 2006.
The price went from about $5 to $25 – 500% increase – and that for a non-precious, highly common metal with no physical world shortage.
There are other factors in the Silver market at play than were in play with Nickel…
As my other article illustrates, we have a worldwide shortage, not just one shortage in exchange. Comex will not be the first to default, infact it will be a catalyst for worldwide shortages as other warehouses are asked for delivery.
The US economy is already on tenterhooks. A precious metals shortage discovery would be just the ticket for mass liquidation of US dollars into stores of wealth such as Gold or Silver. We are already seeing this play out in fact… once entire nations start dumping US Dollars however, it’s a bleak outlook from then on.
The paper price of Silver will head towards zero. As most Silver investors are aware, places like comex trade 100’s of times more paper than what is in their Warehouses. These pieces of paper will approach their true value which is determined by the following formula
(Number of Available Contracts / Actual Inventory) * Market Value of Commodity.
If the actual inventory goes to zero – so to does the price. Do not trade Silver on paper and expect to benefit from the shortage, if anything a speculative SHORT is in play for paper.
Before these paper contract reach their value however, there may be a price burst to the upside before the realisation that paper is worthless. Personally, I won’t be speculating on paper at all during this time.
Inflationary concerns are real for the US Dollar. The Federal Reserve is committed to this “quantative easing” policy which Obama has already committed to allowing with his “stimulus” (read: printing) plans. This factor alone is causing precious metals to increase in paper money terms.
Mining is declining due to the recent bashing Silver has taken over the past 6 months. Most Silver is mined as a secondary metal (70% of production). As base metals decline (and they will further in my opinion – however that is not the scope of this article) Silver will continue to be less attractive. It is only after the price explosion coming where Silver will once again become VERY attractive to mine… but the deficit and immediate demand won’t stop the price going sky high in the interim.
With SO MANY factors at play, its impossible to put a price target for Silver. Anyone who does put a price target on Silver is doing so more for readability than truly understanding just how many factors are at play here.
I do believe however that Silver will be worth more than Gold at some point in time, if only for a short period of time.
January 1st. 2009.