10 December 2014

PBOC paper recommends leasing its reserves to manipulate gold price

“PBOC paper recommends leasing its reserves to manipulate gold price” should have been the headline Koos Jansen used for his blog post on a paper produced within the People’s Bank of China which recommended that China “consider employing some of the PBOC’s gold reserve for market operations and as a macro-control tool.”
For some reason, Koos instead thought that the “key takeaway” from the paper was that in China “the gold on lease is not double counted, leveraged or fractionally backed, as is often the case in Western gold markets” (which is incorrect, but more on that later).
Now saying what the headline should have been (from a Winklebottom point of view) isn’t the same as saying it is true. The reason is because the PBOC paper is focused on what I’d call “good” leasing, that is, leasing to businesses involved in manufacturing gold products, and not leasing for short selling purposes. We can confirm this by the quote “gold leasing is a no-leverage, low-risk transaction”, which only make sense in the context of inventory financing and not short selling. Within that context this quote provides more detail on what was meant by “market operations” and “macro-control”:
“Therefore, while restricting gold export, taking part of PBOC reserve gold to participate in leasing operation is a win-win policy. Specifically, the PBOC may select commercial banks as counter-party to lease out reserve gold when supply is tight. Gold lease rates may be established through bidding, PBOC participation would increase liquidity.”
The paper noted that the supply of physical gold to industrial users was limited at the time, so recommended utilisation of PBOC’s reserves when “supply is tight” and to “increase liquidity” within the lease market to support the gold industry. Assuming the PBOC did implement these recommendations it is likely that today their leasing may be minimal given that the PBOC did implement the recommendation “limitation to imports should be loosened in favor of a policy that is ‘easy in, strict out’” and as such today physical supply to Chinese industry is being met by significant amounts of imported gold.
However, in some sense my headline is true, although not that PBOC is explicitly short selling gold. In the paper they recommend that “enterprise participants can be left to commercial banks to be evaluated for risk of doing business, not unlike evaluating business loans.” In other words, you can trust the banks to be prudent in choosing who to lend gold to. Subsequent events indicate that Chinese banks weren’t so prudent, the result being “bad” leasing for short selling.
By September 2012 we first hear of abuse of improved liquidity in the Chinese leasing market with growing round tripping and collateral trades (the gold tied up in such would be financed/hedged by leasing). Business Week reported “rapid growth” in precious metals leasing business in September 2014. Koos’ sourcing of PBOC paper also confirms the observation in a WGC report that “most of the gold stuck in financing deals has been built up since 2011” (note the PBOC paper is dated January 2011) and provides evidence that PBOC paid attention to the paper’s recommendations. Later we find out how individuals and non-gold businesses were using gold loans in risky leveraged transactions. How much of Chinese bank leasing was for such short selling we don’t know, but given that the paper recommended
  • “increasing gold reserves optimizes the makeup of China’s assets which will lay a good foundation for RMB internationalization” and
  • “when gold in the domestic market is sufficient, or for strategic needs, PBOC may purchase gold from commercial banks to reach its gold reserve target”
it is probably not unreasonable to expect that the PBOC wouldn’t be too worried that a light touch approach to regulating gold leasing may result in downward pressure on gold prices.
Back to Koos’ statement that “the gold on lease is not double counted, leveraged or fractionally backed, as is often the case in Western gold markets”. Regarding double counting, the IMF paper Koos quotes is referring to how many central banks report physical gold and gold loans as one line item. When done this way, the addition of such figures with other figures of gold holdings will result in double counting of physical gold.
However, Koos incorrectly thinks that the SGE rulebook that possession/title of gold from lessor to lessee somehow gets around this problem. The very same transfer occurs in the situations the IMF is referring to, and this doesn’t solve the problem. It is not about transfer but about reporting. To the extent that Chinese bank’s financial reports do not break down physical gold stocks from gold loans, there will be double counting. To the extent that banks following accounting standards, like the Reserve Bank of Australia does, there won’t be double counting.
In respect of Koos' claim that Chinese gold leasing is not fractional backed, well, by definition gold leasing results in a bank being fractionally reserved. As Koos notes, the SGE rules result in transfer of physical gold from the bank, in which case, they no longer have physical gold backing their gold liabilities! Hence they only have a fraction of physical gold against all their gold liabilities. Hence “the gold on lease IS … fractionally backed”. Chinese bullion banks are no different from their Western counterparts, as Koos himself reported: “ICBC launched gold accumulation schemes, swaps, forward hedging, lease/financing, collateralized loans and other financial services ahead of time”. That sounds exactly like what bullion banks do in Western gold markets to me.


  1. So Bron,

    Why don't you simply invite Koos to debate the merits of the issue then?


    Cheers, S. Rex

  2. This post has already invited the debate - by opening the curtains on a critical element of the western based analyst "perception management." No need to limit it to selected participants!

    We are daily awash in stories and reports in the gold blogosphere that reinforce the "bad" western bankstas, versus the good clean players in the East motif.

    It's a storyline that plays well with the audience the metals media targets - gold is cruelly "manipulated" downwards, by the bad guys, but the good guys are getting ready to save the day! In the last year or so, China has become every goldbugs best buddy it seems.

    "For some reason, Koos instead thought" is a master stroke of nuance there Bron... the careful reader knows exactly what that reason is, and how sorely missing thoughtful, independent reviews of the landscape are.

    A very ripe topic for discussion indeed!

  3. Regarding double counting, was his point that in a conventional/western swap or loan there is no third party (SGE) through whom all leases must pass and by whom records of who has what (and when) are kept? Wasn't Koos saying double counting won't happen in the SGE lease system because the ultimate record keeper (SGE) always knows whose gold is being leased, to whom it is leased and for what purpose? Straighten me out.

    I'm glad you are back to blogging more frequently.

  4. Hi Bron,

    Thanks for your take. I will do some additional research and then respond - in public I guess. If I find something that proves you are right I will be happy to rectify my post.

    It's certainly an interesting topic I will investigate thoroughly.


  5. S. Rex,

    A debate in 140 char, seriously? Twitter is good for letting people know what you've done and short comments, but on detailed technical matters I don't think it works

  6. Out of the woodwork,

    Lets not confuse "double counting" with hypothecation or fractionlisation. In the context of Koos reference to the IMF report, double counting means the misreporting of gold assets - mixing up physical with loans.

    Even if the SGE has a "lease system" (note the paper was a recommendation to do leasing on the SGE, I doubt that has happened otherwise we'd be seeing Koos reporting SGE lease statistics) that is only for recording deals and doing transfers, it would not control how a bank reports its balance sheet.

  7. Koos,

    "in public I guess" - you may think I've been harsh making a public comment but you published an article in the public with what I consider some incorrect statements, so the response is public (live by the sword, die by the sword in a way).

    If you had emailed me the very interesting paper with your conclusions, yes I would have had this discussion by email.

    I think you and I have a different take on responsibility in article writing. For me I am aware of the reposting nature of the internet and how this can create memes and how it is almost impossible to pull back anything that is incorrect. Hence I am very careful to only cover topics I am sure about and caveat statements on stuff I'm not.

    Saying that you will "happy to rectify my post" is fine, but will you go out to all those who reposted your stuff (eg GATA mentioned your not doubled counted statement in their repost) and get them to rectify (assuming they would do so anyway)?

    I also prefer public discussion because that provides our readers with an insight into the sometimes opaque nature of the gold market and lets them make up their own mind.

  8. My ignorance in the matter of gold leasing is profound, and maybe it's getting in the way here. I meant to refer to the SGE “leasing services” mentioned in the quotation of SGE rules, not the proposal. I don't see clearly the 'contrast' Koos was pointing out between the highlighted IMF quote about double counting, and the SGE rules it was contrasted with, and was groping for a better understanding. Your understanding is that these rules are entirely irrelevant when it comes to double counting because those involved may still record transactions in a misleading way on their own balance sheets. I thought that perhaps because “all leases are made by commercial banks through Shanghai Gold Exchange (SGE) accounts” that uniformity in accounting was thereby introduced(?) The highlighted part of article 12 suggested to me that there is never ambiguity about who owns what when a transfer of gold is requested between lessor and lessee and so no “multiple [ownership] claims on one gold bar,” which is what Koos said he means by “double counting.” Are commercial banks in China free to record a transaction on their balance sheet in a misleading way when it is recorded in an unambiguous, non-misleading way in their SGE account? If so, then the rules do seem irrelevant.

  9. Accounting rules have some element of interpretation in them. I'll do a follow up post covering this an other issues.

  10. Two interlocking themes here:

    "the sometimes opaque nature of the gold market" is an understated way of describing the manner in which gold has become a primary tool in the advancement of geo-political objectives.

    The established fact of gold's transfer from west to east is being embellished from within the ranks of the gold blogosphere into a narrative that serves interests other than "truth in media."

    Where these two storylines mesh is in the topic at hand - "the China meme"... wherein that countries' accumulation of gold is presented as the anti-dote and eventual lifeboat for western investors disenfranchised by a cabal of corrupt bankstas!

    The subtle perception management employed by this group of inhouse scribes and associated network of metals pundits to take liberties with the (rather opaque indeed) statistical data on hand ... by means of interpretations which ALWAYS lean towards the above described 'black hat/white hat' narrative...

    has seduced and entertained their eager audience for some time now. But NOT necessarily to the ultimate benefit of those battered & baffled metals investors! Which brings us back, full circle, to the 'geo-political objectives' angle;

    who works for whom here? And for what ultimate purpose? All is seldom as it seems - and is portrayed - in the "opaque world of gold!"

    Good to see the scapel being applied with such professional skill in the forensic autopsy of yet another DOA shadowpuppet production - Kudos Bron!

  11. Bron,
    Operative Word being "invite". Twitter being the most expedient delivery means, ergo link provided.
    Oz is notorious for all things being larger than life, and perhaps your personal invitations are of epic proportions exceeding 140 characters, and twitter lacks your favorite font style as well.
    I could have suggested snail mail, but there's always that slight possibility that Koos is unaware that the snails from your side of the ocean are poisonous.

    Cheers, S. Rex

  12. Bron,

    I don't mind you made a public statement on what you consider incorrect info. Comment sections are not often read by the masses. I don't think you've been harsh (although I wouldn't use the 'Wninklebottom approach', which can distort the content perception for readers), if someone writes false info I should be said out loud, and so I highly encourage debating.

    In my opinion there is little true debate in the gold space, much is black or white. I hope we can openly discuss topics. I'm merely interested in the truth, although I have sensed some people won't believe me (coz I work for a PM dealer or coz I write Chinese gold demand is more than what the WGC states).

    I'll reply "In public", because than al my readers, twitter followers and everybody on my newsletter can read how I digested your post. For me it's not about ME being right, it's about accurate info being spread. If I've spread misleading info I will correct myself.

    Everybody who read my first post will very likely bump into my reply to you. How this is all spread through the internet is unfortunately beyond my control, but GATA will post it for sure.


  13. And it is a credit to you Koos that you don't mind the public debate, which is more than I can say for many others in the blogosphere.

  14. I would just like to thank both Koos and Bron, I wish there was more like both of you in the metals space.

  15. I left a comment to Koos response to this post here https://www.bullionstar.com/blog/koos-jansen/gold-chat-bron-suchecki-chinese-gold-lease-market/#comment-1742371754