Tag Archives: gold lease

Zooming In On The Chinese Gold Lease Market

The primary reasons mainstream gold analysts (and the media) don’t use Shanghai Gold Exchange (SGE) withdrawals as an indicator for Chinese wholesale gold demand, are – after a few others have been tested – Chinese Commodity Financing Deals (CCFD). Regarding gold these financing operations can be be conducted through round-tripping or gold leasing. Because of the structure of the Chinese gold market round-tripping gold flows are completely separated from the Chinese domestics gold market – the SGE system, and thus SGE withdrawals. There is no need to further investigate round tripping for our understanding of the Chinese domestic gold market.

Turning to gold leasing. The Chinese gold market is structured as such that gold leases are settled on the SGE; lessor and lessee come to an agreement after which gold is transferred from the lessor’s SGE Bullion Account to the lessee’s SGE Bullion Account. As I’ve stated previously lessees will only withdraw gold from the vaults of the SGE when the leased gold will be used in genuine gold business (The World Gold Council agreed with me in email correspondence), as a lessee that is merely seeking cheap funds has no interest in obtaining physical gold, he prefers to sell the leased gold spot at the SGE for its proceeds. Therefor, leasing gold for acquiring cheap funds adds little distortion to total SGE withdrawals when used as wholesale gold demand indicator.

However, to get to the bottom of this, which seems to be my mission in life, we must zoom in on the Chinese gold lease market. Below I present an article written by Minsheng Banking Corp in 2014, translated by Soh Tiong Hum and BullionStar’s Sales Executive See Hong Kang. The article provides essential data on the Chinese gold lease market, for the first time we can read how total lease volume is compounded, what industry segments are leasing how much gold and in what tenors total volume is divided. In a separated post we will analyze these numbers, as I’m still talking to SGE staff and Chinese banks to be positive on the meaning of all numbers. 

If you are confused about what the article states as being Chinese consumer gold demand (1,170 tonnes in 2013), consider this China Gold Association (CGA) estimate is measured at retail level and likely only from sales by CGA members. To familiarize with all demand metrics used in the Chinese gold market read this post.    

Some data handles:

2013 CGA vs WGC

Translation of the Minsheng Banking Corp article, written by Tang Xiang Bin, 2014:

Gold Supply & Demand, Gold Leasing And Shenzhen Market Research Report

Abstract: In 2013, domestic consumer demand for gold reached a record high of 1,170 tonnes for the first time, more than 35 % over 2012. As rationality returns to consumers, 2014 domestic gold demand may retrace back to normal levels after being depleted by last year’s explosive growth. As imports are able to meet gold demand, China’s gold market shall move from shortage to balance. We expect this year’s first quarter gold and jewelry spending year on year growth will drop to 10 – 20 % of the normal level, while second quarter gold consumption demand will slow further. Expected 2014 domestic gold demand should stay between 900 – 1200 tonnes.

2013 ushered in explosive growth in the gold lease market. The domestic gold lease volume grew substantially to 1,070 tonnes, an increase of 268 % y/y. Based on demand, 2013 gold leasing by enterprises and brand makers reached 781.1 tonnes, 73 % of the year’s total volume, which shows that China’s jewelry market is the most important customer segment. From the rate of growth, interbank gold loans grew rapidly. 2013 interbank leasing increased 439 % y/y which indicates that financialization of gold between China’s banks have strengthened.

Because China’s economy and credit market both face risk of deleveraging this year, gold leasing can satisfy banks’ need to expand their business as well as meet financing needs of gold enterprises when there is a credit crunch in the background. Therefore deleveraging is conducive to the growth of the gold lease market.

At the moment, Shenzhen already has the largest domestic gold and jewelry processing base, the largest center of demand for spot gold, the largest gold wholesale center, the largest physical gold settlement and the largest OTC market. In other words, Shenzhen has a competitive advantage for developing gold market activities. Backed by strong demand and an industrial chain, gold leasing in Shenzhen has great potential and space for development.

End of abstract

minsheng gold lease market report 2014

Domestic gold demand in 2013 grew enormously due to substantial fall in the gold price. National gold consumption grew to all-time high of 1,170 tonnes, a 35 % increase y/y. Although last year’s gold demand was not evenly distributed, volatile fluctuation between domestic and foreign gold prices reflected the fluctuation in demand. Large increases in gold imports were able to satisfy this sudden increase in demand. We expect this year’s jewelry consumption growth to retrace to normal levels. Gold consumption in 2014 shall maintain between 900 – 1200 tonnes. Following a rise of gold inventory in recent years, gold leasing enters a phase of explosive growth. 2013 gold leasing reached 1,070 tonnes worth RMB 300.6 billion, 268 % higher y/y. With deleveraging going on in 2014, both banks and clients have stronger interest to push gold leasing. Therefore gold leasing should maintain the trend of high-speed growth, hopefully becoming a bright spot when banks are going through downturn.

After explosive growth in 2013, domestic gold demand should retrace to normal this year

Gold demand in 2013 goes through huge growth

China’s domestic gold demand experienced explosive growth last year, overtaking India as the world’s number one gold consumer. For the whole of 2013, transacted spot gold (AU99.99) at Shanghai Gold Exchange hit 3,188 tonnes, 280 % growth y/y. Explosive growth shows demand for spot gold at the exchange exceeded the 2012 level. Besides the exchange, domestic consumer demand (especially in the first half of the year) also experienced explosive growth. For the whole of last year, Gold jewelry consumption broke a record with RMB 296 billion, 34 % increase y/y. In the second quarter, gold jewelry consumption broke quarterly record with RMB 82 billion, 28 % of the whole year.

Gold imports can satisfy domestic gold demand

Increase in gold imports satisfied explosive growth in gold demand. In 2013, gold demand grew explosively. 2,197 tonnes of physical gold left the SGE that year, a 193 % increase y/y. Because domestic production of gold is unable to meet demand, imports became an effective means. Import from Hong Kong increased significantly. In 2013, gold import from Hong Kong reached 1,498 tonnes, 179% increase y/y. Importing gold can satisfy domestic demand effectively.

As gold imports increased, the ability of commercial banks to supply the gold market increased visibly. Since 2012, China’s import from Hong Kong and SGE’s settlement volume on a monthly basis appeared to be consistent. The logic is really simple: The more gold the commercial banks are able to import, the stronger the ability of other participants in the gold market to provide gold liquidity. Conversely, if the banks lower the volume of gold imports, the ability of participants in the market to provide liquidity for gold would weaken. This year, the banks operating in the gold market have seen a test of their ability to react to a demand growth explosion.

Last April’s drop in the international gold price stimulated an explosive increase in demand for spot gold. Vibrant domestic demand quickly depleted inventory so that SGE’s Au(T+D) settlement dropped rapidly. Inventory dropped to 24.85 tonnes, the lowest level in May that implies power by banks and enterprises to deploy gold nearly withered. Gold imports stabilized domestic supply. Deployment by banks and enterprises recovered shortly, SGE’s Au(T+D) settlement also returned to normal.

After rise in demand, domestic gold demand will retrace to normal

It’s noteworthy that 2013’s explosive demand may be ‘abnormal’ consumption because it was triggered by the major correction in the international gold price since many years. As rationality returns, it is difficult to sustain this demand this year. Fact is consumption demand in the second half of 2013 already began weakening. China’s gold jewelry consumption growth y/y already weakened from July’s 44.7 % to 33.9 % at year-end. Demand at the SGE also weakened visibly. SGE’s monthly spot gold transactions fell from a year-high of 358 tonnes in July to 210 tonnes by October. In addition, SGE’s monthly withdrawals fell from 235 tonnes in July to 139 tonnes in October. We estimate that both figures will continue to slowdown and we should see the growth rate return to its’ normal 10 – 20% and gold demand at between 900 – 1200 tonnes.

The scale of gold lease market will continue to grow quickly

Over the past few years, the gold lease market has developed from nothing till the scale it is today. At last count in 2013, 23 commercial banks have gold leasing operations and the businesses participating in leasing have mushroomed to close to a thousand. In terms of scale, last years leasing market grew explosively with leased volume reaching 1,070 tonnes, a 268% increase y/y. Based on demand, 2013 gold leasing by enterprises and brand makers reached 781.1 tonnes, 73% of that year’s total volume, which shows that China’s jewelry market is the most important customer group. From the rate of growth, interbank gold loans grew rapidly. 2013 interbank leasing increased 439% y/y, which indicates that financialization of gold between China’s banks has strengthened. Because China’s economy and credit market both face risk of deleveraging this year, gold leasing can satisfy banks’ need to expand their business as well as meet financing needs from gold enterprises when there is a credit crunch in the background. Therefore deleveraging is conducive to the growth of gold leasing.

Gold lease market grew explosively in recent years

The gold leasing volume reached 398.06 tonnes in 2012. The breakdown of the lease volume:

  • Interbank leasing was 21.82 tonnes, 5.48% of total.
  • Refining companies leased 72.9 tonnes, 18.31% of total.
  • 110 tonnes was used to produce brand name gold products, ie, gold products with brand names, 27.78 % of total.
  • Leasing for jewelry and industrial use accounted for 192.76 tonnes, 48.42% of total.

In 2013, the gold leasing volume grew substantially to 1,070 tonnes, a 268 % increase. The breakdown of the lease volume: 

  • Interbank leasing was 117.7 tonnes, 11% of total.
  • Refining companies leased 171.2 tonnes, 16% of total.
  • 363.8 tonnes was used to produce brand name gold products, ie, gold products with brand names, 34% of total.
  • Leasing for jewelry and industrial use accounted for 417.3 tonnes, 39% of total.

Based on growth, gold lease demand in 2013 increased by more than 100%. Interbank lending grew by 439 %, refining companies leasing grew 135 % and brand name companies leasing increased 116 %. Increase in loans between commercial banks indicate that rise in demand pushed the growth in activity between commercial peers as well as increasing financialization of gold in China’s banks. Based on demand, 2013 gold leasing by enterprises and brand makers reached 781.1 tonnes, 73% of that year’s total volume, which shows that China’s jewelry market is the most important customer group.

The Chinese gold lease rate reached its top in the second half of 2013 at 10.2 %, the lowest rate was 2.1 %, the average was 4.19 %. Among various tenors of lease contracts, 1 year leasing accounted for 44.26 % of total contracts, 6 to 12 months was 35.24 %, 3 to 6 months was 10.38 % and less than 3 months 10.12 %.

Gold lease market has prospects to be a bright spot in banking that is deleveraging

China’s economy and credit market are facing risk of deleveraging this year. In the deleveraging process, ‘big’ business drivers that banks enjoyed in the past few years are consolidating whereas ‘small’ drivers that have unique proposition have the prospects to become a bright spot.

Firstly, first quarter economic statistics came in below market expectations. Important economic numbers like manufacturing value added, retail sales and investments look weak which leaves hints that first quarter economic growth is likely to come in below government target. Secondly, this year’s M2, new loans, financing numbers are evidently slowing down which indicate that China is undergoing deleveraging. In this macro environment, banks are trapped in a dilemma. On one hand, deleveraging forces banks to be wary of risks associated with ‘big’ businesses that have been expanding tremendously. On the other, banks are pressured to deliver profits. Under pressure from such concerns, banks are more willing to develop businesses that are not constrained, not high-risk and have unique propositions. Gold leasing can satisfy banks’ need to expand their business as well as meet financing needs of gold enterprises when there is a credit crunch in the background. Therefore deleveraging is conducive to the growth of gold leasing.

Along with the flow, Shenzhen has best competitive advantage to develop gold market

Map Shenzhen China

After nearly 2 decades, a multi-layered gold market was shaped in Shenzhen. It’s supported by manufacturing, driven by physical trade and supplemented by leasing. In the 1980s, Shenzhen took over Hong Kong’s jewelry manufacturing by offering lower costs. After 20 years of development, Shenzhen became an integrated production, value-added processing and wholesale chain. According to data from the People’s Bank of China, the value of gold and gem-set jewelry production and processing is 70% of the total (Chinese jewelry production and processing) and the export value for gold jewelry is 30% of the total (Chinese jewelry production and processing). Shenzhen, therefore, qualifies to be the largest processing base, the largest wholesale center and most competitive city. Based on such an achievement, Shenzhen conceived the earliest domestic jewelry retail market, which transformed a very visible gold market.

At the moment the Shenzhen gold market has SGE membership system, commercial banks and OTC gold trading. Products include jewelry, physical gold, paper gold as well as gold leasing. SGE’s historical data shows that Shenzhen physical gold delivery is 45% of national total that makes it the largest delivery location. Data from the Shenzhen Gold and Jewelry Association states that gold usage in Shenzhen city is 90% of national total. Shenzhen is therefore China’s largest spot gold market driven by trading in physical gold. Based on incomplete data, there were 921 finished gold lease deals in Shenzhen in 2013, with an accumulated gold lease volume of nearly 110 tonnes. This number was 26.36% of the total gold lease volume of gold-using enterprises in ChinaAdditionally, Shenzhen has a massive OTC market but lacks sufficient data for evaluation. Based on estimates, OTC market volume in Shenzhen is comparable to spot trading on the SGE. The OTC market comes in 2 parts:

  1. Non-standard physical gold including gold ore, recycled gold etc. This gold comes from domestic gold sources, passes through Shenzhen and Hong Kong and forms a production-supply-retail chain.
  2. Black market speculation including locking in gold prices, downside hedging and simple profiteering from gold spot and futures.

Shenzhen is already China’s most important gold market. It is the largest jewelry-processing base, the largest demand for spot gold, the largest wholesale center, the largest physical gold delivery location and the largest OTC market. Shenzhen has the most competitive advantage to develop gold business. Backed by strong gold demand and manufacturing, gold leasing in Shenzhen also has tremendous potential and room for development.

Gold Chat About The Chinese Gold Lease Market

As some of you may have noticed Bron Suchecki, manager at the Perth Mint and publisher of the Goldchat blog, wrote a critical article about my recent post on the Chinese gold lease market.

Firstly I would like to thank him for the work he does writing critical articles on blogs in the gold space that have lost touch with reality. From my point of view there is a lot of misleading information out there, if it wasn’t for people like him there would be even more presumably. It’s valuable to have industry professionals participate in blogging to get all angles of the market, which is often displayed as black or white. Bron’s article made me rethink the key takeaway of my initial post and led to more thorough research.

Bron and I had email correspondence today, as we do occasionally on all sorts of subjects, and we agreed it would be best for the debate to respond in a new post for me, so all my readers become notified of my opinion on Bron’s post.

As I have already stated in the comment section on his blog, I didn’t agree with Bron’s Winklebottom point of view, which can distort the perception of his content and turns his writing into a black post. If I ignore his approach I can reply on the content:

1) While twisting a bit Bron suggests the PBOC might manipulate the price of gold through gold leasing. From his article [brackets added by me]:

However, in some sense my headline [PBOC paper recommends leasing its reserves to manipulate gold price] 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.

His headline is not true in my opinion, because the Chinese gold market is in the process of opening up, but gold export (in general trade) is still prohibited in China.

2) I agree with Bron in the Chinese gold market there is also “bad” leasing, as I described in the third simplified example in the introduction of  my post (including a link to my article from January 21 explaining these practices in China). More on this later.

3) In the sixth paragraph of his post he states Chinese gold leasing involves round tripping. While leasing and round tripping can be both categorized as Chinese Commodity Financing Deals (CCFD), they are two completely different procedures. I’ve written extensively about this in Chinese Gold Trade Rules And Financing Deals Explained. This post clearly explains round tripping has got nothing to do with the Chinese domestic gold market (the SGE) or with the Chinese gold leasing, as the latter is always done through the SGE. However, Bron entangles leasing with round tripping, leading to incorrect conclusions.

4) Moving on to the most important part of the discussion; is leased gold double counted in China? On SGE level certainly not, on balance sheets it can be; I edited my previous post on this subject as it was inaccurate in the way presented at first.

After reading Bron’s post I read some more bank documents, had a interesting phone call with ICBC’s precious metals trading desk and emailed with my regular sources in the mainland. There’s always much more to learn when continuing to dig deeper. At this stage this is what I know and what I don’t know:

It’s clear all leases are done through the SGE where there can be no double counting (either you have gold in your SGE Bullion Account or not). The lessor and lessee are both required to have an SGE account. What I don’t know is how all parties involved disclose the transactions on their balance sheet. Let’s look at some examples of lease procedures.

The ICBC precious metals trader I spoke to told me ICBC has little gold of itself to be leased, most of their leased gold is used from third parties. These parties are either SGE members, such as refineries, or overseas banks that supply gold through the Chinese OTC market. He didn’t know how his lease trades were processed by ICBC’s accountants. I’ll try to call the accountants, though I’ve been warned they might not speak English.

Another source in mainland China wrote me:

The wholesale OTC gold market in China is done through SGE accounts. The two parties negotiate off the SGE (usually through the CFETS – China Foreign Exchange Trade System) but gold is settled through SGE accounts.

While speaking to the ICBC employee I passingly discussed the possibilities for BullionStar to open a Shanghai International Gold Exchange (SGEI) account. Through this account BullionStar could trade physical gold in the Shanghai Free Trade Zone (FTZ), with the option to export, or trade gold in the mainland, without having the option to export. (read this post for the workings of the SGEI). If BullionStar would have gold credited to its SGEI account in the mainland we would have the option to lease it through ICBC, I was told.

Are there more ways for ICBC to source gold for leasing? Maybe.

Any Chinese citizen can walk into an ICBC branch to open a personal SGE account through ICBC as its broker (this is one of the precious metals products ICBC offers to customers). However, gold that is credited to a personal SGE account is impossible for ICBC to use at its own discretion for leasing.

Another ICBC gold product is Ruyi Gold. Through this product customers can save at the bank (or withdrawal) Ruyi bank bars, which are not standard SGE gold bars. For this reason Ruyi Gold deposits are also impossible for ICBC to touch for leasing.

Screen Shot 2014-12-11 at 12.47.21 AM
ICBC’s considerations for Ruyi Gold.

Than there is ICBC’s Gold Accumulation Plan, “launched by ICBC partnered with the World Gold Council”. No SGE account is required for the Gold Accumulation Plan. From ICBC:

The Gold Accumulation Plan is a service for customers who open Gold Accumulation Plan accounts at ICBC and sign the accumulation agreement to buy ICBC gold asset equity in regular periods…

Though I have no hard evidence, the Gold Accumulation Plan smells a bit like unallocated gold. Possibly ICBC might use a fraction of the Accumulation Plan gold pool to lease (pure speculation!).


What stood out for me after additional research was that ICBC, and perhaps the other Chinese banks involved in leasing as well, is mainly an intermediary that facilitates between lessor and lessee, while striking a fee on all transactions. Consequently I think every lease (ex fee) would increase ICBC’s assets and liabilities by the same amount on their balance sheet. How the actual lessor and lessee handle their balance sheet I don’t know. Maybe Bron would knows more, if I recall correctly he has a background in accounting.

There is a lot more to learn on this topic that I surely will publish in forthcoming posts. Anybody how has additional sources, further data, or a different interpretation, please feel free to comment below.

A Close Look At The Chinese Gold Lease Market

An important segment of the Chinese gold market that is often misunderstood in my opinion is the gold lease market. To get a better perspective on gold leasing in China I present a translation of a paper written by the PBOC, Problems Affecting The Development Of The Gold Lease Market And Recommendations, originally published in 2011.

Although the lease market was much smaller back then, the structure of the market hasn’t changed. Bullet points from the paper:

  • All leases are done through the Shanghai Gold Exchange (SGE).
  • In 2011 the PBOC had no gold leased, but the paper suggests the PBOC may participate in the domestic gold lease market to provide liquidity and develop the lease market. (If the PBOC has any gold leased at this moment I don’t know.)
  • The PBOC wanted to boost the lease market in 2011 to develop the overall Chinese gold industry – the mining and jewelry business. (This has been realized, the Chinese lease, mining and jewelry markets have grown substantially.)
  • There was a shortage of physical gold back then to meet demand in the lease market. The paper recommends to lift import restrictions, while preserving export restrictions. (This has also been realized; net gold import was 1,500 tonnes in 2013.)

To illustrate gold leasing by Western central banks, please read the next quotes from an IMF paper, Repurchase Agreements, Securities Lending, Gold Swaps And Gold Loans: An Updatepublished in 2004:

Gold loans or deposits are undertaken by monetary authorities to obtain a non-holding gain return on gold which otherwise earns none. The gold is “lent to” (or “deposited with”) a resident or nonresident financial institution (such as a bullion bank) or another party in the gold market with which the monetary authority has dealings and confidence and which is probably acting as an intermediary for a gold dealer or gold miner which has a temporary shortage of gold.

In particular, gold may be double counted with either a gold swap or gold loan/deposit if the party acquiring the gold were to on-sell it outright, because both the original owner and the outright purchaser would report ownership of the gold.

In contrast, the SGE rulebooks:

Article 3

Any member or customer who is the holder of such precious metals as gold, platinum, or silver that are placed under the custody of the Exchange may use the leasing services offered by the Exchange.

Article 4

The lessor and lessee to a stock of gold, platinum, silver or other precious metals to be leased shall sign a lease agreement. The Exchange shall be responsible for transferring the possession of such precious metals in accordance with the requests put forth by the lessor and the lessee.

Article 12

Upon a lessor approved for transfer and the corresponding lessee each submits a leasing request to the Exchange’s system, the system shall verify the requests and transfer the precious metals from the lessor’s Bullion Account into the lessee’s Bullion Account.

UPDATE 12 December 2014: after a post from Bron Suchecki it made me realize the two examples above are hard to compare. My reply on Bron’s post can be read here.  

For the ones who are unfamiliar with gold leasing I have penned three simplified examples:

  • A gold miner needs funds to invest in new production goods. It can borrow dollars from a bank at an 7 % interest rate, or borrow gold from a central bank at 2 % – the gold lease rate is usually lower than the dollar interest rate. The miner chooses to borrow 10,000 ounces from a central bank and sells it spot at $1,500 an ounce. The proceeds are $15,000,000 that can be used to invest in new production goods. In a years time the miner has mined 10,200 ounces to repay the principal debt plus interest (the interest on gold loans can be settled in gold or dollars, depending on the contract). Through gold leasing the miner has acquired cheap funding, if compared to a dollar loan. The movement in the price of gold during the lease period is neglected in this example.
  • A jeweler needs funds to buy gold stock for production. It can borrow dollars from a bank for 7 %, or borrow gold for 2 %. The jeweler borrows 10,000 ounces, with which it can start fabricating jewelry. To hedge itself against price fluctuations the jeweler can sell spot, for example, 10 % of the 10,000 ounces it has borrowed (1,000 ounces at $1,500 makes $1,500,000) to buy gold futures contracts in order to lock in a future price. After a year the jeweler has sold the 9,000 ounces (as jewelry) for dollars and can take delivery of the long futures contracts to repay the gold loan. If one buys (long) 10,000 ounces through a futures contract for delivery in a year’s time, initially he is required to pay a margin, for example 10 %. When the contract expires and he wants to take physical delivery he must pay the remaining 90 %.
  • A pseculator is looking for cheap funds. It can borrow dollars from a bank for 7 %, or borrow gold for 2 %. He borrows 10,000 ounces, sells it spot at $1,500 an ounce. The proceeds are $15,000,000 and subsequently these newly acquired funds can be used to invest in higher yielding products (> 2 %). If the trader chooses to hedge itself in the futures market is up to him. After a year the 10,000 ounces plus interest need to be repaid, either the trader can purchase gold with the profits made on the higher yielding investment or from delivery of futures contracts.

The general consensus in the gold space is that gold leasing is bad thing, though in essence it’s not. If gold is a currency what’s wrong with lending it? The problems emerge when there are multiple claims on one gold bar.

The oncoming paper is translated by Soh Tiong Hum, who I like to thank from the bottom of my heart. He has translated most of the essential articles on my blog and has helped us all in understanding the Chinese gold market. Without him we would never have gotten such accurate information out of China. Thanks TH!

The People’s Bank Of China

Problems Affecting The Development Of The Gold Lease Market And Recommendations

Source: Shanghai Finance, Date: January 2011, Authors: Ji Ming, Yan Xiaomei, Zhou Qiong, People’s Bank of China, Shanghai Headquarters.

Summary: This paper describes the current status of China’s gold lease market, discusses the problems that exist in the gold lease business and puts forward policy recommendations.

1. Brief introduction of gold leasing

The concept of gold leasing

Gold leasing is a business model carried out by commercial banks whereby physical gold is leased to fellow banks or enterprises, the same amount of physical gold is to be returned at the expiration of a contracted period together with an interest or fee. In practice, according to the nature of the counter-party, an arrangement between commercial banks is also known as gold lending whereas commercial banks to lease gold to business enterprises is called gold leasing.

Background of the emergence of international gold leasing

International gold leasing business began in the 1980s, when central banks were willing to lent part of their gold reserves to commercial banks, commercial banks then provided gold financing services, thus increasing physical support of gold in the international gold market. The appearance of gold leasing was widely welcomed by gold producers and gold jewelers. For gold producers [mining companies], gold leased from banks offered supply ahead of upcoming production, which could be sold spot to pay for operating expenses and to lock in stable prices in anticipation of a fall in the price of gold. As for jewelers, gold leasing helps to lower costs of goods sold, avoids the impact of gold price fluctuation on company finance and lowers associated market risk. The world’s first gold leasing deal was done in 1988 when three banks including the Royal Bank of Canada leased 30 tonnes to a US miner. The domestic commercial bank gold lease business in China came into being after 2005 following rapid developments of the country’s gold market with emerging demand for gold leasing from gold producers, jewelers and small and medium commercial banks.

The international gold lease business model

After twenty years of development, the gold lease market is more mature in terms of market size, body composition, pricing models and system development. Central banks (especially banks of European countries) are major suppliers of physical gold for leasing. Central banks lease out part of their gold reserves at lower rates (for example 1 % per annum) to bullion banks like HSBC, Scotiabank and JP Morgan. Once the gold is in their possession, these bullion banks can make two kinds of deals:

  1. Sell gold for US Dollars, and then use the US Dollars to invest in assets with higher returns like government bonds for spread income. These kind of deals are also known as a ‘carry trade’.
  2. The second deal, which is a traditional lease deal, is to lease physical gold to other commercial banks or producers and jewelers. At expiration, interest can be settled in physical gold or currency. The gold lease rate (GLR) is LIBOR minus GOFO, with tenors from 1 month to 1 year.

International gold leasing is very market-oriented. It has a high level of transparency as rates are published daily on major websites. The gold lease rate plays an important role in the gold market; on one hand the gold lease rate is the benchmark for gold derivatives and new product innovation in the international gold market, on the other hand it is seen as an indicator for short term central bank-controlled supply and demand, because central banks lease supply affects the gold lease rate and causes gold price fluctuations.

2. Current shape of China’s gold lease market

Status of gold lease market participants

Current participants in the gold lease market are commercial banks, gold miners and jewelers. Commercial banks stand on the supply side while gold producers and jewelers fall on the demand side. Industrial gold users capture the bulk of demand with jewelers as the main body. Jewelers utilize gold leasing to lower working capital requirement and avoid price fluctuations. There is less participation from gold producers because gold producers have always been a minority among members of the Shanghai Gold Exchange (SGE). Besides, gold producers have the option to hedge market risks through gold futures or by delaying physical delivery; because of complicated vetting and approval required by leasing operations, gold producers are not keen about leasing. China Construction Bank is a major commercial bank participating in gold leasing.

Besides market participants discussed above, the SGE provides a crucial role in gold leasing. The SGE’s block trading system is the trading platform used by gold leasing participants; the SGE also provides transfer and settlement services.

Mechanism of domestic gold lease operations

China’s gold leasing does not involve the central bank. Gold leasing takes place between commercial banks and enterprises as well as between commercial banks, the former being key. Commercial banks have similar processes but there is no standardized approach.

  1. An enterprise that intends to be a lessee approaches a branch office of a commercial bank with a rate request and application.
  2. The commercial bank carries out due diligence and then submits a review to their head office for approval.
  3. Upon approval the head office quotes a lease rate with the international gold lease rate as a benchmark plus additional basis points taking into account the potential lessee’s credit, physical gold management costs and other factors.
  4. If potential lessee accepts the offer, a commercial bank branch manager will sign a lease contract with the customer including the terms and conditions clearly laid out.
  5. According to the “Shanghai Gold Exchange Lease Transfer Procedure”, after signing the lease, the head office of the commercial bank and lessee, or his agent, shall make a lease application through the exchange’s membership system. After verification, the SGE shall transfer the commercial bank’s gold from its SGE bullion account to the lessee’s SGE bullion account. The lessee can now trade the physical gold that it has leased or withdrawal the gold from vaults.
  6. Upon expiration of the lease the lessee shall deposit or purchase physical gold through the SGE to repay the gold. Corresponding physical gold will be transferred from the lessee’s SGE bullion account to the commercial bank’s bullion account. Leasing fees involved will be settled in currency. At this point, the lease is completed.

Leasing between commercial banks basically follow the flow between commercial bank and enterprise but is carried out between head offices of both parties. As commercial banks enjoy higher credit ratings, gold leasing rate is slightly lower than the rate applied to enterprises.

The size of domestic gold leasing business

China’s first leasing deal was done on 11 March 2005 when China Gold Coin Incorporation [the Chinese Mint] leased 800 kilograms of gold from the Bank of China (BOC). More organizations participated in gold leasing once they understood the process. A new bull market in gold arrived after 2007 that spurred leasing activity and doubled the size of transactions. As of 2009, cumulative leasing to enterprises by commercial banks reached 200 tons while trading volume reached an average annual growth rate of 2 – 3 times. Leasing commanded an increasing share of the SGE’s trading volume and became one of SGE’s businesses with the highest development potential.

3. Issues that exist in the current leasing business

Limited domestic supply for physical gold

Since the establishment of the SGE, China’s physical gold market has grown rapidly every year with rising efficiency from domestic sources. Annual domestic production, however, is under 300 tones while demand is 400 tons. Under-supply persisted for years combined with low turnover in domestic physical gold so that the demand of some players could not be met by the market. Therefore many domestic and foreign commercial banks adopt a proactive attitude and have high hopes for gold leasing, especially foreign banks like Scotiabank and ANZ bank, which have rich operating experience.

The biggest problem at the moment is source physical gold. Firstly, after long operating under direction, key participants in the gold market including commercial banks have limited physical gold in reserve. Not enough to support development of the huge leasing business. Secondly, gold produced by domestic producers are sold directly into the market. From capital utilization point of view, these producers have little incentive to retain large inventory. Thirdly, China limits import of goods so that apart from the four banks [currently 15 banks] that can import physical gold according to quota, no other financial entity has any channel to acquire physical gold from the international market. In addition, the PBOC’s gold reserves have never entered the domestic gold market. Over the long run, shortage of physical supply will curb development of gold leasing in a big way.

Few players, the system is not mature

Gold leasing requires demand and supply of physical gold to have a match through price discovery. A physical gold user must find a supplier, build trust, reach an agreement on the gold lease rate and then arrange the transactions, custody, settlement, transfer and so on to be completed on time. A sophisticated gold lease market requires an electronic trading platform, physical custodian and settlement entity as well as accompanying support. At the moment there are few participating organizations in China. Among physical suppliers, there are only seven commercial banks. There are also very few enterprises on the demand side. In the leasing business, most participants are large scale gold merchants reaching private deals with lessors that they have a long established relationship with. Most of market demand is not met because information is unavailable or parties that want to deal are unable to build trust or evaluate credit. As can be seen in recent years, more small and medium commercial banks want to participate in gold leasing. They, as well as recent foreign entrants, show strong appetite but because of poor policy, understanding and inadequate service, their participation can be improved.

Differences in the way commercial banks operate

A survey of some commercial banks found there are differences in the way banks operate.

One, there are differences in commercial banks their management model. For example, ICBC’s gold leasing is centrally managed by head office with centrally defined direction and operating procedures. On the other hand, CCB’s head office only supplies physical gold but business management is run out of branch offices. CCB does not have a specialized management for gold leasing.

Second, there are differences in the way the gold leasing rate is determined. CCB’s leasing rate is derived from its own leasing rate from the international market, plus risk premium and management fee. ICBC’s asks for a sales fee on top of gold leasing rates and quotes the gold lease rate in fixed rate and floating rate.

Third, difference appears in the way counter-parties are selected. ICBC sets requirements for potential lessees, for example having an existing fund settlement account with the bank but CCB accepts lease applications from potential lessees that are arranged through third party banks. Each commercial bank also has different templates for lease agreement, penalty for non-compliance with leasing terms and so on.

Information is inadequate

At the moment, most leases are privately negotiated. Apart from information available at the SGE, the PBOC and its subsidiaries have few other sources for information. The PBOC does not fully follow the development of the leasing business much less provide direction. Despite rapid growth in the gold lease business since 2007, the PBOC’s level of attention in this business is not high. Many SGE members remain uninformed about the business and even deals between commercial banks are few in number and volume.

4. Policy recommendations

Actively acquire new sources of physical gold

China should consider policies that increase the number of sources available to market participants. Limitation to imports should be loosened in favor of a policy that is ‘easy in, strict out’. Specifically, set up a qualification for the Big Four banks according to their market scope and level of development and contribution, so as to increase their imports in accordance with performance of joint stock company. Physical gold import must meet the volume required for gold leasing. Concurrently, foreign banks that have plentiful experience in gold leasing such as HSBC, Standard Charted, Scotiabank and ANZ may be given approval to import physical gold from their head office within the “People’s Republic of China Foreign Exchange Management Regulations”. Additionally, consider employing some of the PBOC’s gold reserve for market operations and as a macro-control tool.

In the first half of 2010, official gold reserve increased from 600 tons to 1054 tons – sixth placed in the world. From a strategic point of view, increasing gold reserves optimizes the makeup of China’s assets which will lay a good foundation for RMB internationalization. Gold however is an asset that has little yield. 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. 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. 

Set up electronic trading platform for gold pricing and transparency

At the moment, gold leasing’s core areas – physical handling, custody and settlement are done at SGE and demand and supply participants are members and customers of the exchange. Setting up a price-finding and information platform at the SGE is a foremost way to expand the exchange’s service competency. Once an electronic trading platform is set up, commercial banks and large gold merchants can use the platform according to their own business model, to engage in one-to-one and one-to-many trading and price discovery, which will lead to higher physical gold turnover. For example, bank A may want to borrow 2 tonnes of gold whereas B and C each have 1 tonnes available. A can approach B and C concurrently so that all 3 parties reach a deal. The electronic trading platform is conducive to a fair and transparent gold lease system. By disclosing gold lease information on the electronic platform, participants can get more timely information on lease volume and rates. This will give them better judgment of demand and supply and is good for reference and strategizing. Supervisory functions would also be improved leading to more effective monitoring.

Improving effectiveness of regulation

Firstly, perfect various control measures. The PBOC should quickly come up with its guidance for the gold lease business, to come up with regulatory principles separately for businesses between commercial banks and businesses between commercial banks and enterprises so as to achieve an orderly market to avoid unfair competition. Next, the SGE must become supervisor in the lease market – to perfect various control measures. Thirdly, commercial banks in the leasing business must define management measures, report to the PBOC, the China Banking Regulatory Commission and the SGE, to accept supervision and management.

Methods to regulate business. Gold leasing is a no-leverage, low-risk transaction where the biggest risk encountered by participants is the credit risk of counter-parties. Over the long run, commercial banks constantly improve risk management but also establish a set of effective risk management rules. They have accumulated a lot of experience to select counter-parties and evaluating exposure. Therefore regulators do not have to set barriers of entry for commercial banks that want to participate in gold leasing as long as they are SGE members that are financial in nature and can be both domestic or foreign. Enterprise participants can be left to commercial banks to be evaluated for risk of doing business, not unlike evaluating business loans. In day-to-day operation, PBOC regulation should focus on monitoring market information. Firstly, support SGE business information disclosure, timely release information on market supply and demand and report on penalizing violators. Secondly, look out for irregular transactions (example, wide discrepancy between market rate and transacted rate), conduct in-depth analysis on the occurrence of irregularities and provide warnings for systemic risk.