The end of paper gold and silver markets

May 20, 2021·Alasdair Macleod
This article looks at the likely consequences of the Bank for International Settlements’ introduction of the net stable funding requirement (NSFR) for bank balance sheets, insofar as they apply to their positions in gold, silver and other commodity markets.

If they are introduced as proposed, banks will face significant financing penalties for taking trading positions in derivatives. The problem is particularly important for the London gold market, as described in last week’s article on this subject. Therefore they are likely to withdraw from providing derivative liquidity and associated services.

This article delves into the consequences of the NSFR leading to the end of the London forward markets in gold and silver. Replacement demand for physical metal appears bound to rise, and an assessment is therefore made of available gold not tied up in jewellery and industrial uses. An analysis of gold leasing by central banks, leading to double ownership of physical gold, is included.

The conclusion is that unless the BIS has an ulterior motive to trigger a chaotic financial reset of some sort, it is a case of regulators not understanding the market consequences of their actions.


Last week I explained why as they stand the new Basel 3 regulations will make it uneconomic for banks to continue to run bullion trading desks.[i] The introduction of the net stable funding requirement (NSFR) means that mainland European banks, of which ten are LBMA members including the Swiss, will have to comply with the new regulations from the end of June, and all UK banks, in effect the entire banking membership of the London Bullion Market Association (LBMA) will have to comply by the year-end. There are 43 LBMA members listed as banks, and on Comex there are currently 17 with long and 27 with short positions in the Swaps category, which represent bullion bank trading desks in the dominant futures contracts. So being similar, the Comex numbers must broadly replicate those operating in London. It is therefore reasonable to assume that if the LBMA’s banking membership ceases dealings in unallocated bullion, then very few will continue to deal on Comex — the LBMA crowd having ceased taking trading positions.

We are discussing not gold or silver but their derivatives. But there is a problem borne out of the LBMA’s insistence that it involves bullion, albeit unallocated, and not derivatives. The distinction could be important, depending on how the UK regulator applies the NSFR rules. This is because in the calculation of required stable funding, gold consumes 85% of available stable funding while gold liabilities contribute no available stable funding at all. The effect is to impart a negative factor into a bank’s overall net stable funding calculation, making unallocated gold trading hopelessly uneconomic in terms of deployment of total funding capital. The alternative, which does not appear to be under the LBMA’s consideration, is to admit that the whole unallocated gold trading business has nothing to do with gold bullion but is in fact gold derivatives; in which case capital funding penalties under the NSFR would be broadly limited to imbalances between derivative liabilities and derivative assets.

Consequently, it appears that an allocation backstop of 85% of available stable funding (ASF) must be swallowed in the case of gold, which does not appear to be the case if the LBMA confesses to the paper charade.[ii]

There are in London, in effect, two markets conflated into one, but they must not be confused. The unallocated market, otherwise known as dealing for forward settlement, is the product of bank credit expansion, not as the LBMA claims, physical metal whose bar origins, weights and fineness are not recorded for convenience’s sake. Perhaps the LBMA would like to let us know where they think it’s all stored; it’s certainly not in LBMA vaults, where after deducting headline figures for custodial gold the float reduces to as little as a few hundred tonnes. Unsurprisingly, the Bank for International Settlements lists these transactions as over-the-counter derivatives for statistical purposes, so we know how they are regarded by the international regulator.

Physical gold held on behalf of customers is never recorded on bank balance sheets. If a bank owns physical gold in its own vault, an independent vault, or allocated to it by another bank acting as custodian with its own vaulting facilities then that appears as an asset on its balance sheet. In that case, it can hedge out the price risk with a matching liability for a zero price-haircut within Basel 3 rules. But this has nothing to do with the NSFR calculation.

Clearly, unless the NSFR calculation is amended at the last moment, following its introduction the character of bullion markets will become markedly different. Gone will be roughly $600bn of paper gold[iii], while presumably some of the paper demand released will migrate to physical metal. There is also the question of how outstanding imbalances will be resolved. This article assesses the consequences.

Unknown motives and politics

It is difficult to understand why the Financial Stability Board, under whose aegis the Basel Committee on Banking Supervision has produced Basel 3, seems intent on destroying derivative markets for gold, silver and also for other commodities. That will be the consequence of the introduction of the NSFR calculation in these markets. As the supreme authority overseeing fiat currencies, the Bank for International Settlements, which oversees the FSB, has no love for gold. One can explain the desire to do away with it: as the riskless form of money, it has been at the centre of monetary affairs for ever and the desire to do away with it must be overwhelming for neo-Keynesian modernists. But if that is the case, then it will be a serious misjudgement, because as this article reveals, the consequence of withdrawing paper supply is likely to drive the gold price significantly higher, along with silver and a host of other important commodity prices. Furthermore, this delayed act, first published in 2014, now comes at a time of rapidly rising commodity prices, reflecting the unprecedented acceleration of global money-printing in 2020, which ironically proves the importance of sound money — gold.

Already, tight, gold silver and commodity markets cannot accommodate a migration out of defunct paper into physical metals and energy without massive price rises to defuse the unsatisfied demand unleashed by this action. Perhaps the regulators at the FSB know this. If they do, then we can only conclude it is a deliberate attempt at a reset of all commodity markets. Bank corruption, particularly in precious metals has been rife: major banks have been regularly fined and continue to manipulate and spoof these markets, fines being seen as little more than a cost of doing business. These are systemic risks a regulator should address. But to assume the FSB is shutting down these paper markets to curb this behaviour exhibits a touching faith in its altruism.

Another popular theory is of an even wider financial reset. The BIS is coordinating research into central bank digital currencies, which if adopted cuts out the commercial banks altogether. In theory, it would allow central banks to more effectively target stimulus and do away with the destabilising cycle of bank credit. The ultimate aim could be to demote and then remove commercial banks from the financial system entirely, in which context the closure of derivative markets by regulatory means makes some sense.

Quantifying gold derivatives

We know from the Bank for International Settlements’ statistics that at the end of the second half of 2020, gold forwards and swaps totalled $530bn, which at the then price of $1898 was the equivalent of 8,685 tonnes of gold in paper form.[iv] But other than a triannual survey, the next being due in 2022, according to the BIS this figure is culled from dealers, mainly banks, in only twelve jurisdictions. With respect to commodities and foreign exchanges, these twelve jurisdictions have been found to capture roughly 80% of the total, so grossed up the gold tonnage rises to an equivalent of 10,806.

The LBMA positions are just part of the BIS total. The LBMA only records monthly settlements in London (Loco London) reported by the four clearing members that own and operate London Precious Metals Clearing Limited. They deal solely with LBMA members. The daily average settlement for December 2020 was recorded at 18.9 million ounces, or 588 tonnes. This is only one eighteenth of the BIS figure quoted above. The first thing to note is that daily settlements are not the same thing as outstanding obligations. Furthermore, the BIS statistic includes swaps and forwards not recorded in London nor, for that matter, are they necessarily settled through the LPMCL. But even taking these factors into account the difference between the BIS and LBMA figures still need further explanation.

In an analysis for Hardman & Co published in January 2020, Paul Mylchreest identified two other sources of turnover not included in the LBMA figures: trade between LBMA members and non-members, and central banks dealing in unallocated gold.[v]

Now let us assume that the new Basel regulations have the effect of bringing unallocated bank trading in gold to an end. From the value of outstanding OTC contracts recorded by the BIS adjusted for the trends of its triannual surveys, we can take it to be about 10,800 tonnes. Assuming LBMA members on their own account run relatively minor net positions in the context of this enormous figure, we can assume this outstanding balance is mostly split between central banks, other non-LBMA users of the unallocated market, and OTC trades recorded in other centres.

We have no idea what the central bank position is at any one time, but it would be surprising if they took long positions. Instead, they can be expected to attempt to bolster market confidence in fiat currencies, and in particular the US dollar by selling gold. And by shorting paper gold, they also would seek to encourage physical supply by shaking out weak holders in ETFs. That being the case, not only has the central bank cohort no reason to be long of gold derivatives, but if they have positions, they are almost certainly short. The only likely exception is when a central bank which has leased gold sold into the market might hedge the price risk of not getting it back.

The ending, therefore, of London’s forward settlement market would remove an artificial supply of gold, which we can estimate to be the equivalent of over 10,800 tonnes of gold. To this we should add the net short Swap position on Comex, comprised of bullion bank trading desks, which is currently 486 tonnes. From the main sources of derivative supply, we can therefore see roughly 11,300 tonnes of paper gold supply being withdrawn from the markets if the bullion bank cohort ceases trading in derivative gold. We should now examine the position of central banks further.

Central bank leasing — yet to be resolved

In 2002, Frank Veneroso, a respected analyst, concluded that central banks had leased anything between 10,000—16,000 tonnes of gold at that time — the upper figure being about half of global central bank gold reserves at that time. He gave his reasoning at a speech in Lima on 17 May that year.[vi] Central bank leased gold was being sold into the market for dollars, which as part of a carry trade were being reinvested by banks in US Treasury bills and the like, the cost of finance being a gold lease rate of one or two per cent, for a yield of six or seven. Veneroso concluded that much of the gold was repurposed into jewellery and had effectively disappeared from the market.

Between the 1980s and the turn of the millennium, gold had been in a bear market, so the general public, including investing institutions, were either genuine sellers (which was in limited physical quantities) or hedging and speculating on the short side using derivatives. This enabled the bullion banks to hedge out the price risk on gold that would have to be eventually returned to central banks by going long for forward delivery relatively cheaply. But at the time of Veneroso’s speech, gold was $325, having risen from about $255 over the previous fourteen months.

Conditions were changing from a long-established bear market, which favoured gold leasing activity, into the beginning of a new bullish phase. Leasing and even undeclared sales then became a tool for central banks to supply physical liquidity to the gold market, either to rescue bullion banks from being badly squeezed or simply to suppress the price.

The leased gold might not have always left the vaults of central banks in the main gold dealing centres, as Veneroso assumed. However, during the period covered by Veneroso’s analysis, I regularly lunched at The Banker’s Club opposite the Bank of England’s rear entrance in Lothbury. On most days, security vans could be observed entering and leaving the Bank’s premises, transporting physical gold to and from the Bank’s vaults. So perhaps Veneroso was right about physical being sold and delivered into the market, at least to some degree.[vii]

In March 2008 gold breached $1,000 for the first time. It would have been impossible for central banks to recover their leased gold by then, because Chinese and Indian demand was beginning to suck physical gold out of Western markets at an alarming rate, in any case significantly faster than any replacement by available mine and scrap supplies. It might appear that leased gold could then have been returned to central banks during the 2012—2015 bear market, but again, Chinese and Indian demand continued to absorb most of the available physical released by any ETF sales and other sources of physical supply.

Alternatively, there would have to have been substantial selling of Western-owned stockpiles, and there is no evidence of that. The best one can say is that in some years, notably 2013, there was some ETF liquidation, but not in the quantities required to resolve the leasing problem. By way of confirmation, in 2014 I was told by one of the large Swiss refiners that they were working double shifts seven days a week turning 400-ounce LBMA bars into 1 kilo 9999 bars, the new Chinese standard. Some of the LBMA bars arrived in a poor condition and obviously had not been touched for decades, scraped out from the darkest recesses in deep-storage vaults. Furthermore, customers from the Middle East were submitting LBMA bars for refining into the new 1 kilo standard and taking them back to be re-vaulted in that form. Not only did this indicate that they were aligning themselves with China’s growing gold presence, but they were definitely not selling. Clearly, the 40% decline in the gold price between September 2011 and December 2015 led to substantial unrecorded increases in physical demand, cleaning out Western vaults. It would not have been possible for central banks to regain their leased gold.

There was, perhaps, further circumstantial evidence of the leasing problem, when Germany decided to withdraw her earmarked gold from the New York Fed’s vaults. The desire to do so was publicly justified on the basis that Germany’s gold no longer needed to be stored abroad, because the threat of a Soviet invasion had been removed by the collapse of communism. But given that the suppression of gold involved leasing and gold swaps in significant quantities in order to maintain the dollar’s credibility, was the true reason nothing to do with Soviet presence but that the Bundesbank suspected its gold was being used for this purpose without its permission?

The Bundesbank’s first action was to request to inspect its gold, a request that was flatly refused. Following that refusal, the decision was taken to begin a process of repatriation. Why it was partial is not entirely clear but could be explained if the Bundesbank suspected it wasn’t actually there. There would be nothing to be gained by demanding the return of all of it, but a partial return might at least enable the New York Fed to find some gold from elsewhere and avoid a public crisis. It turned out that after a series of meetings it was agreed to repatriate only 300 tonnes of Germany’s gold over a period of seven years. In fact, it was returned three years early. The Netherlands also sought, and obtained, 122.5 tonnes of her gold repatriated from New York. Austria arranged for the repatriation of some of its gold from London. While some of these repatriations were in the wake of public demands, they were never important enough to trigger them on their own. But they are consistent with substantial quantities being leased and assessments by the central banks repatriating national gold stocks that they are better secured on their own territory.

Since the days, as Veneroso put it, when central bank gold ended up adorning Asian women, leasing procedures, being targeted at providing liquidity and at supressing the gold price, will have changed. Wherever possible, leased gold need not leave the Bank of England’s or the New York Fed’s vaults. A ledger entry, or book entry transfer confirming it is at the disposal of the lessee is all that’s required, and for the payment for the sale of leased gold to be arranged through the appropriate channels. And from there it can be reassigned by another book entry transfer. We saw this in action when GLD, the gold ETF, ended up with the Bank of England recorded as a sub-custodian holding some 70 tonnes of gold last August precisely in these conditions.

In a leasing contract, ownership remains with the lessor. When arranging gold leasing, we can be sure that in recent times the Bank of England will have comforted lessors that their gold never leaves the Bank of England’s vault, so there’s no need to worry about repossession. This would be an operational justification for continuing leasing activities to offset physical shortages in the market. But the question over how much leased gold that has left the Bank of England and the New York Fed in the past remains unresolved, but it is likely to be in significant quantities with Veneroso’s lower estimate perhaps a bare minimum.

The true quantity of monetary gold

It is commonly stated that the above-ground gold stock is 200,000 tonnes. While that may be a reasonable approximation, most of it is not monetary gold in any sense of the definition and is not therefore its monetary supply.

The statist definition of monetary gold is physical bullion held as part of a central bank’s declared monetary reserves. According to the IMF the current total of all such monetary gold is 35,244 tonnes, though as we have seen from the foregoing paragraphs it is unlikely to be all there or unencumbered. But to this we must add gold bullion hoarded and stored by all other parties on the assumption that it is either a more stable store of monetary value than fiat or an insurance against fiat currencies losing purchasing power. It must be in a form immediately available for monetary purposes, being in bar or coin form. Of an estimated 200,000 tonnes of above ground gold, it is generally assumed that 60% is used for other purposes, mainly jewellery but also some industrial purposes, leaving 80,000 tonnes of monetary gold conforming with our definition. After subtracting official monetary gold from the total, we are left with 44,756 tonnes.

In October 2014 I published an article explaining why China had considerably more gold in storage than her declared reserves, and I estimated that by 2002, when the Chinese government removed the ban on personal ownership and opened the Shanghai Gold Exchange, the state could have acquired up to 25,000 tonnes.[viii] Much of this gold would have been leased gold sold into the London market. (Veneroso’s statement about ending up adorning Asian women could not have been true for Chinese women, because they were not permitted to own gold until 2002 and Indian imports were severely restricted for some of the relevant time).

That China had accumulated substantial undeclared bullion stocks was confirmed to me anecdotally by experienced China watchers. If we treat that as part of our estimate of monetary gold, and make an allowance for Russia, of perhaps an unrecorded 5,000 tonnes, monetary gold in the hands of everyone else appears to amount to only 15,000 tonnes.

But this figure will have been bolstered by central bank leasing activity, perhaps even doubled, with leased gold appearing to have two or even more owners, and the actual possession being in undeclared Asian hands. It is in this context that the threat to derivative trading from Basel 3 must be viewed. Not only will paper supply estimated at 11,300 tonnes equivalent in unregulated and regulated markets be threatened with removal, but there is an additional unknown figure of central bank leasing and swaps to be unwound. Obviously, there is significant guesswork involved, but if the numbers outlined herein have the slightest validity, the ending of gold derivative markets, if it is permitted to go ahead, will create a major gold crisis, of which the BIS regulators seem blissfully unaware.


The mechanics behind dealing in the LBMA silver market are the same as for unallocated gold. The LPMCL settlement system is the same, providing access only to LBMA members. The basis of calculating the net stable funding requirement is the same, so silver derivatives suffer from the same balance sheet disincentives. The principal difference is no silver is vaulted at the Bank of England, nor, so far as we are aware, in the vaults of any other Western central bank.

In terms of demand, it is also primarily an industrial metal, and is mostly consumed. According to the Silver Institute, of a total annual demand of roughly a billion ounces that is forecast in the current year, 253 million ounces is identified as investment demand and a further 150 million ounces as ETF/ETP demand. Bizarrely, the report estimates there will be a fall in ETF demand, when it is already rising. And of the supply, only 18.5% is from recycling.

The BIS figure for outstanding silver OTC derivatives is included in “Other precious metals” at $64bn. The same NSFR treatment for all commodity derivatives, including energy, involves an estimated $858bn’s worth. Not only is the introduction of the NSFR disruptive of precious metal markets, but it also threatens to disrupt wider commodities at a time when their prices are already increasing rapidly as a consequence of falling purchasing powers for fiat currencies.

[i] See The end of the LBMA is nigh

[ii] See the LBMA’s letter to the Prudential Regulatory Authority on the NSFR (undated but sent end-April)

[iii]BIS-recorded OTC gold derivatives plus Swap positions and their equivalents in regulated futures markets.

[iv] See

[v] See

[vi] See

[vii] Terry Smeeton, referred to by Veneroso in his Lima speech used to join me for lunch from time to time at the Banker’s Club. I never talked business with him — now I wish I had!

[viii] See

The views and opinions expressed in this article are those of the author(s) and do not reflect those of Goldmoney, unless expressly stated. The article is for general information purposes only and does not constitute either Goldmoney or the author(s) providing you with legal, financial, tax, investment, or accounting advice. You should not act or rely on any information contained in the article without first seeking independent professional advice. Care has been taken to ensure that the information in the article is reliable; however, Goldmoney does not represent that it is accurate, complete, up-to-date and/or to be taken as an indication of future results and it should not be relied upon as such. Goldmoney will not be held responsible for any claim, loss, damage, or inconvenience caused as a result of any information or opinion contained in this article and any action taken as a result of the opinions and information contained in this article is at your own risk.