I get your attention with the title? Good! It's a great headline, isn't it?
Well, stick with me for a minute and I'll try to live up to my seemingly
And for you noobs that weren't attracted like moths to a freeway headlight by
this title, you can get up to speed here, here and here.
First, let me ask you a question. Which of these two scenarios should be more
instrumental in the transition to Freegold?
1.) A bottom-up shift in value perception as millions and even billions of
small savers use their meager dollars all at once to bid up the price of
2.) A top-down shift in risk perception as the very few physical gold holders
of size in the world all at once withdraw their physical from the
Just think about this question. That is its only purpose. And one more; Would
either of these events be exclusive of the other?
One other item I would like to touch on before I get started is the
distinction between loaning or leasing your gold to someone else versus
putting your gold up as collateral for a fiat loan that you need, sometimes
called a "swap".
In the former case you are handing over your gold to someone else in exchange
for an income stream (the lease rate) as well as the promise that your gold
will be returned at a predetermined time in the future. In the latter, you
are handing over your gold to someone else in exchange for a lump sum of
money, usually close to the full value of your gold, as well as the promise
that you can buy your gold back for that same amount of money plus a fee
(interest rate) at a predetermined time in the future.
In the former case, when leasing out your gold, you are generally said to be
"deploying a 'dead' asset in pursuit of a yield." While in the
latter case, putting up your gold asset as collateral for a loan, you are
likely trying to keep other creditors at bay, paying them off with cash from
this new loan rather than letting them take your gold. And, depending on who
your new creditor is, you may be said to be "protecting your gold
asset" from those other creditors who had intended to take it away for
I wanted to clarify this distinction because I read one article where the
analyst seemed to view these two acts as one and the same, and in so doing,
in my opinion, drew the wrong conclusion about the recent BIS gold swap.
Do any of you check the GOFO rate from time to time just to see if it is
getting close to zero? GOFO is a relatively good proxy for the gold contango
because it represents the cost basis a dealer calculates to take either side
of a 'gold for currency swap' over a fixed length of time. It is also a good proxy
for liquidity in the gold market. It should never turn negative because that
would mean it costs more to borrow gold than to borrow dollars. (GOFO = $
interest rate - gold lease interest rate) In other words, if GOFO goes
negative, the message is that gold is more precious than dollars.
As long as the GOFO rate is positive, the borrowing of dollars will cost you
more "elbow grease" (debt service) than borrowing gold. So it can
be said that there is a bid from gold for dollars as long as the GOFO is positive!
When it turns negative, it can be said there is NO bid from gold for dollars.
Dollar forward mechanism – LBMA
I check the GOFO rate every few days, but more for amusement than analysis
lately as it has been rising!
(A side note: Last week when I clicked my GOFO bookmark that
I have been using for years, for the first time ever it asked me to log in,
which apparently costs "an application fee of £1,000 (which is
not refundable if the application is rejected for whatever reason) and an
annual levy of £2,500." I'm sure this was just a normal LBMA
site improvement though, because they put the new URL for free GOFO
data in the small print down at the bottom. And they also improved the actual
GOFO data by reducing the font size to tiny, compressing the columns, and
reducing the contrast to light-gray on white background making it much easier
on these tired old eyes.)
LBMA "website improvements" - Click image to view actual size
Looking at the 3 month GOFO rate for the calendar years of 2005, 2006 and
2007 (here) we see a steady
gradual rise at an average annual clip of 34%, with a maximum of 79% in 2005
and a minimum of 1% in 2007. Yet so far this year we have a 221% rise from
Jan. 29 through July 23 alone.
That 221% rate change in 6 months is pretty high volatility for this normally
stable metric except in the remote instances of impending doom. But
surprisingly, the rapid rate change this year has been in the direction of
"nothing to see here, folks."
So here is the basic story of gold backwardation. On September 29, 1999 gold
went into backwardation for the first time in modern history. The cause is
commonly cited as the Washington Agreement on Gold that
happened three days earlier in Washington, DC. This backwardation manifested
itself in three common metrics. First, the price of gold shot up.
Second, the gold lease rate spiked. And third, the GOFO rate went negative in
all five durations, from 1 month to 12 months.
What is important here is both the meaning of these anomalies and the message
they send to the marketplace. The GOFO rate is basically a measure of
unencumbered physical gold's desire to bid for dollars. And the lease rate is
the banks' bid to borrow your gold so they can sell it and then do whatever
it is that banks do with your money.
So the message of a high lease rate is "lease us your gold, PLEASE, and
we'll pay you handsomely for it." Remember, a lease is where you
"rent out" an asset to derive an income stream. And a swap (like
GOFO) is where you need a loan, so you offer an asset as collateral and then
YOU pay the income stream to someone else. Only with a negative GOFO rate,
you retain control of the gold PLUS you receive the income stream coming in,
so why would anyone LEASE their gold in this backwardation scenario?
For that matter, why would you even SWAP your gold in this scenario? Unless,
perhaps, you were desperate for dollars and you were swapping your gold with
someone you knew for a fact would hold it safe for you and do nothing else
with it. Like a "rich uncle" perhaps?
I know this is complicated, but just take a look at the lease rate and GOFO
charts from Sept. 29, 1999:
The point to take home here is that the spikes in these charts DO represent potentially
imminent collapse of the dollar, but they are not the cause of the potential
collapse, they are the system's response to it. In a way, these charts are to
a collapse like a thermometer is to the temperature. Or like a body's immune
response is to a bug.
They don't show the actual backwardation, they show the "immune
system" response to it.
These images ARE what backwardation looks like. But in a strange way
backwardation is kind of like AIDS to the fiat money system. Once it's in
there, you can't get it out. And you can't actually see the HIV virus. All
you can see are the antibodies that attack it. That's how you know it's in
there, eating away at the system.
A few years after the Sept. 29, 1999 backwardation event the following
conversation was revealed and can be found on many gold websites:
"In front of 3 witnesses, Bank of England Governor Eddie George spoke to
Nicholas J. Morrell (CEO of Lonmin Plc) after the Washington Agreement gold
price explosion in Sept/Oct 1999. Mr. George said "We looked into the
abyss if the gold price rose further. A further rise would have taken down
one or several trading houses, which might have taken down all the rest in
Therefore at any price, at any cost, the central banks had to quell the gold
price, manage it. It was very difficult to get the gold price under control
but we have now succeeded. The US Fed was very active in getting the gold
price down. So was the U.K."
Jump forward nine years to 2008. On Thursday, November 20, in the middle of
the unfolding global financial crisis, the 1 and 2 month GOFO rates suddenly
turned negative. By November 25 they were back to positive again. The lease
rate also spiked as you can see in the chart above.
Four years earlier, in 2004, Antal E. Fekete had written a paper in which he
explained what backwardation in the gold market actually means. Very simply,
gold backwardation signals the permanent end of the current system and the
beginning of dollar hyperinflation [FOFOA: and the beginning of Freegold?].
Here is his 2004 paper:
What Gold And Silver
Analysts Overlook, May 1, 2004
...As it is not set up to satisfy demand for delivery on 100 percent of the
open interest, the gold futures market will default. Exchange officials will
declare a “liquidation only” policy to offset long positions in
gold. At that point all offers to sell cash gold will be withdrawn. Gold is
not for sale at any price. The shorts are absolved of their failure to
deliver on their gold futures contracts.
...Previous descriptions of hyperinflation purporting to explain the descent
of a currency into the abyss of worthlessness do so in terms of the quantity
theory of money. My explanation of the hyperinflation that is staring us in
the face is very different. I dismiss the quantity theory of money as a
linear model that is not applicable.
...Moreover, previous episodes of hyperinflation affected isolated countries
which had embraced the regime of irredeemable currency out of desperation,
while the rest of the world stayed the course of monetary rectitude. In the
present situation the entire world has been inflicted with irredeemable
...My description of hyperinflation is not in terms of the quantity theory of
money, but in terms of a model where the relentlessly declining gold basis
leads to backwardation destroying the gold futures market.
The dollar and other irredeemable currencies will go the way of the assignat...
Backwardation in gold should therefore be considered the self-destroying
mechanism for the regime of irredeemable currency that “only one man in
a million may identify and understand” (my thanks to Keynes for the
felicitous phrase). This is where supply/demand analysis is utterly useless.
The huge stocks of monetary gold are still in existence, yet zero supply
confronts infinite demand.
Fekete followed this paper up with several more in 2006 and 2007 on the
subjects of the gold basis and backwardation:
The Rise And Fall Of
The Gold Basis, June 23, 2006
Non-Monetary Commodities, June 25, 2006
The Last Contango In
Washington, June 30, 2006
Gold, Interest, Basis, Mar.
Gold Vanishing Into
Private Hoards, May 31, 2007
Over the years he became well known as possibly the only person in the world
ringing this particular warning bell. Then, on Dec. 5, 2008, Fekete published
RED ALERT: GOLD BACKWARDATION!!!
(Yes, that's where I got the title.)
But Fekete wasn't watching the "reactive" GOFO and Lease rates, he
was carefully analyzing the gold basis, looking at specific trading prices in
the spot and gold futures markets. And on Dec. 5 he announced the beginning
of gold backwardation as of Dec. 2.
Fekete not only believed that when backwardation finally turns permanent it
will end the fiat dollar, but he also boldly proclaimed that the gold basis
was the foolproof metric! That it could not be falsified!
gives way to backwardation in all contract spreads, never again to return, it
is a foolproof indication that no deliverable monetary [metal] exists. People
with inside information have snapped it up in anticipation of an imminent
What he meant was that the gold basis, the difference between the price of
cash gold and contract futures of different maturities, could not be
manipulated! And he not only proclaimed this loud and clear, but he also put
his money where his mouth was, developing an investment fund that would
profit from tracking the gold basis.
At this point, in late November/early December '08, everyone and his brother
was on "backwardation watch". Backwardation quickly became
associated with the expected COMEX default. (COMEX Default & Backwardation?)
Fekete's articles were prolific, and everyone was eating them up, myself
included. Remember this site? Vaporize COMEX countDOWN « Meltdown It
was started on Nov. 29, 2008 and later abandoned.
Fekete followed that Dec. 5 piece with several more on the subject, and
"backwardation watch" continued in earnest for at least the next
RED ALERT: GOLD BACKWARDATION!!!, Dec.
There Is No Fever Like Gold Fever, Dec.
Shook The World, Dec. 14, 2008
Backward Thinking On
Backwardation, Dec. 18, 2008
Forward Thinking On
Backwardation, Dec. 21, 2008
The Vanishing Of The
Gold Basis and its implications for the international monetary system, June
More Dress Rehearsal
For The Last Contango, Aug. 25, 2009
To this day I believe that Fekete was absolutely correct that backwardation
is THE existential threat to the system that he said it was. Where he went
wrong was in his assertion that the gold basis was the only metric that could
not be rigged. He has since admitted as much.
The Gold Basis Is Dead
-- Long Live The Gold Basis!, Oct. 17, 2009
A year ago I
conducted a Seminar on the gold basis and backwardation in Canberra,
Australia. I suggested to my audience that the gold basis (premium in the
nearby futures on spot gold, with negative basis meaning backwardation) was a
“pristine indicator that, unlike the gold price, cannot be manipulated or falsified
by the banks or by the government. Thus it is a true
measure of the perennial vanishing of spot gold from the market, never to
return, at least not as long as the present fiat money system endures.”
That was then. Today we are one year older and that much more experienced. We now know that the banks and the
government have in the meantime found a way or two to manipulate the gold
basis as well. Next month I have another Seminar coming
up in Canberra. I shall address the problem of gold basis, giving a full
account of what we know about the efforts of the powers that be in trying to
falsify this most important indicator, the guiding star of refugees who have
entrusted their fate to a golden dinghy on a stormy sea. To the government,
the gold basis is like the naughty child who blurts out unpleasant truths. He
must be gagged and silenced at all hazards. Fool’s gold basis is even
more important than fool’s gold in terms of the number of people
I would now like to draw your attention to this March 25, 2009 research paper
put out by Goldman Sachs:
Forecasting Gold as a Commodity
The inventory-demand curve is quite stable and downward sloping, with less
inventories of gold being held on the COMEX as gold lease rates increase.
Following the onset of the current financial crisis in the second half of
2007, however, the gold lease rate began to climb to a much higher level than
would have been expected, given the level of physical gold inventories...
The link between the current financial crisis and the increased demand for
physical gold inventory can be seen explicitly by looking at the correlation
between gold lease rates in the recent period and the TED spread or the
difference in (one-year) interest rates between LIBOR and the US Treasury...
As the degree of counter-party risk increases, so too does the demand for
physical gold… the gold lease rates are well explained by the
TED-spread and the level of COMEX registered gold inventories.
...COMEX inventories and nominal interest rates drive the shape of the gold
forward curve, specifically the price spread between near- and long-dated
contracts. High inventory levels place downward pressure on near-dated prices
relative to long-dated prices, as the market anticipates inventories
returning to more normal levels over time.
...The gold lease rate is the interest that must be paid (in our case in US
dollars) to lease, or borrow, physical gold for a specified period of time.
Consequently, this can be viewed as the explicit cost of borrowing gold to
hold for a period of time or the opportunity cost of holding one’s own
gold and not lending it out to another.
Clearly, someone at Goldman Sachs was studying the gold basis, the related
lease rates and the relationship of these metrics to the dwindling COMEX
inventories in late 2008/early 2009. And, of course, why does Goldman Sachs
study any market metric? I know you know the answer to this question.
Goldman Sachs studies market metrics to figure out HOW TO RIG THEM! Then they
publish a paper about how their findings would work in a normal free market,
and then they laugh all the way to the bank. Oh wait, they are the
bank. So I guess they just spin in their chairs laughing, huh?
Lease Rates and
It is a curious observation that published gold lease rates have been
decidedly negative ever since Goldman Sachs released that paper, isn't it?
And as Izabella Kaminska at ft.com/alphaville
observes, "negative [lease] rates should suggest some pretty
hefty Comex gold stocks," even by the logic in Goldman's own paper.
But oh, so mysteriously, COMEX "registered gold" has diverged
during this same timeframe from the overall picture painted by negative lease
She also points out that COMEX registered stock hit a significant multi-year
low in Dec. 2009 and then "magically" recovered. And I'll add that
the GOFO rate hit very close to zero a month later and then also
Dollars Bidding for
Gold? Or Gold Bidding for Dollars?
When you think about the message that the lease rate sends, it is directly
tied to the liquidity the dollar desperately needs. On Sept. 29, 1999 the
message was "lease us your gold, PLEASE, and we'll pay you handsomely
for it." Today the message is "we don't need to borrow your gold,
and if you insist on lending it to us, it'll cost you."
Now, if I am a liquidity creator for the dying $IMFS - a bullion bank - how
do I create dollar liquidity? I take a piece of unencumbered physical gold
(owned or borrowed) and I fractionalize it. I sell it off to the extent that
the probability of a delivery demand is lower than my physical reserves. And
in the process, I am creating DEMAND FOR DOLLARS because my "golden
tickets" are bidding on dollars. Remember what ANOTHER said...
Date: Fri Jan 23 1998 19:01
ANOTHER (THOUGHTS!) ID#60253:
All modern digital currencies do not go into an investment, they move THRU
it... There is an alternative. Gold! It is the only medium that currencies do
not "move thru". It is the only Money that cannot be valued by
currencies. It is gold that denominates currency. It is to say "gold
moves thru paper currencies".
This is the key to EVERYTHING!!! It is not "gold liquidity"
that the bullion banks create... it is DOLLAR LIQUIDITY. Dollars bidding on
MSFT stock set the value of that stock. If dollars are frantically bidding on
MSFT (high velocity), the stock skyrockets. If dollars stop bidding
for MSFT all at once (low velocity), the price falls to zero. This is true
for everything in the world except gold.
Gold bids for dollars. If gold stops bidding for dollars (low gold velocity),
the price (in gold) of a dollar falls to zero. This is backwardation!
Fekete says backwardation is when "zero [gold] supply confronts infinite
[dollar] demand." I am saying it is when "infinite supply of
dollars confronts zero demand from real, physical gold... in the necessary
VOLUME." So what's the difference? Viewed this way, can anyone show me
how we are not there right now? And I'm not talking about your local gold
dealer bidding on your $1,200 with his gold coin. I'm talking about Giant
hoards of unencumbered physical gold the dollar NEEDS bids from.
Think about it. You can't make it cold in July by simply rigging the
And in my - purely speculative - analysis, "the BIS gold swap"
CONFIRMS this view!
What the bullion banks do is they take a piece of gold and they inflate it
1,000% and sometimes up to 10,000% so it appears to be a SUPER BID for
dollars. And they prefer to do this by LEASING gold (borrowing your gold)
rather than buying it outright. It's a lot cheaper that way.
But right now the signal going out to the marketplace is "we don't need
to borrow your gold, and if you insist on us borrowing it from you, it'll
cost you." It is a completely bogus signal, and has been for more than a
And just as with all bogus signals that the government, the Fed and Goldman
Sachs create, the response is the same. The marketplace withdraws from games
with bogus signals. Volume dries up, and Goldman Sachs ends up playing
against itself to create the show. Just like price controls create
shortages... SAME EXACT CONCEPT.
So Goldman Sachs (the $IMFS) has rigged the GOFO as a big F-YOU to Antal
Fekete.. but it shot itself in the foot in the process.
Just like unemployment isn't really 9%, I think it is possible that gold is
actually in permanent backwardation at this very moment and may have been for
a while now. You can't change the temperature by simply rigging the
thermometer. But you can't know the exact temperature either.
The dollar NEEDS voluntary bids from private physical gold to survive.
My guess is that pool of REAL bids of size is bone dry and cracking. And
"dollar liquidity" is just a cheap façade at this point.
This is why the dollar NEEDS a rising gold price. As the price (for selling,
not borrowing gold) rises, weak little bits of gold here and there will bid
Of course that won't be enough (dollar demand from gold) to float the dollar
for long. Gold must EXPLODE to reach equilibrium. And the knock-on effects of
that explosion will kill the ability to run perpetual deficits, which will
kill the value of all outstanding dollar debt, and on and on and on. It's all
I don't view gold backwardation as only its simple metric signals that can be
falsified. I view it as the terminal disease behind the metrics that has been
present in the system and periodically erupting since 1999. I don't need a
working thermometer to notice that it's hot outside and I don't need an
accurate blood test to see that the patient is already dead.
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