Because gold is "dug out of the ground somewhere in Africa, and put back in the ground and guarded", the carrying costs can be expensive. For this reason, central banks will lend their gold to one of the "bullion banks".
The bullion banks can then lend the central bank gold, for a fee to somebody else. The borrower, more often than not, sells or delivers the gold.
Now, if you borrow something and then sell it, who is the legitimate owner?
Because the gold was borrowed, it must be paid back and for this reason if you borrowed the gold and sold the gold at $500, you are looking at very hefty losses with the paper price pushing $1,600.
But the real kicker from the question comes when you look at Exchange Traded Funds.
I found this, very good article over at theaureport.com that seems to sum it the question nicely:
On how an Exchange Traded Fund (ETF) is created:
"........ commercial banks and brokerage houses acting as "Authorized Participants" (APs) contribute defined "Creation Basket Deposits" of assets to the ETF, receiving in return "Creation Units" which are then sold to investors at a premium over net asset value."
Further
".....In our report of December 22, Mr. Barisheff pointed out that, in gathering the assets that are contributed to the GLD Trust, the AP (Authorised Participant) may either buy the gold or lease (borrow) it from a central bank."
And
"....It is hard to see how unencumbered title on the part of the ETF would be compatible with the use of leased gold. In common commercial practice a lessor always retains title to leased property, and a lease transfers only the right to use property.
The central bank retains an ownership claim on the specific number of ounces that have been leased."
For those with an inquisitive mind, it is well worth the read, if just to see how smoke and mirrors of paper gold.
It is also interesting to see a massive spike in gold lease rates in June of this year, with the twelve month rate doubling!
