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By Antal E. Fekete
December 2, 2008, was a landmark in the saga of the collapsing international
monetary system, yet it did not deserve to be reported in the press: gold
went to backwardation for the first time ever in history. The facts are as
follows: on December 2nd, at the Comex in New York, December gold futures
(last delivery: December 31) were quoted at 1.98% discount to spot, while February
gold futures (last delivery: February 27, 2009) were quoted at 0.14% discount
to spot. (All percentages annualized.) The condition got worse on December
3rd, when the corresponding figures were 2% and 0.29%. This means that the
gold basis has turned negative, and the condition of backwardation persisted
for at least 48 hours. I am writing this in the wee hours of December 4th,
when trading of gold futures has not yet started in New York.
According to the December 3rd Comex delivery report, there are 11,759 notices
to take delivery. This represents 1.1759 million ounces of gold, while the
Comex-approved warehouses hold 2.9 million ounces. Thus 40% of the total
amount will have to be delivered by December 31st. Since not all the gold in
the warehouses is available for delivery, Comex supply of gold falls far
short of the demand at present rates. Futures markets in gold are breaking
down. Paper gold is progressively being discredited.
Already there was a slight backwardation in gold at the expiry of a previous
active contract month, but it never spilled over to the next active contract
month, as it does now: backwardation in the December contract is spilling
over to the February contract which at last reading was 0.36%. Silver is also
in backwardation, with the discount on silver futures being about twice that
on gold futures.
As those who attended my seminar on the gold basis in Canberra last month
know, the gold basis is a pristine, incorruptible measure of trust, or the
lack of it in case it turns negative, in paper money. Of course, it is too
early to say whether gold has gone to permanent backwardation, or whether the
condition will rectify itself (it probably will). Be that as it may, it does
not matter. The fact that it has happened is the coup de grâce for the
regime of irredeemable currency. It will bleed to death, maybe rather slowly,
even if no other hits, blows, or shocks are dealt to the system. Very few
people realize what is going on and, of course, official sources and the news
media won’t be helpful to them to explain the significance of all this.
I am trying to be helpful to the discriminating reader.
Gold going to permanent backwardation means that gold is no longer for sale
at any price, whether it is quoted in dollars, yens, euros, or Swiss francs.
The situation is exactly the same as it has been for years: gold is not for
sale at any price quoted in Zimbabwe currency, however high the quote is. To
put it differently, all offers to sell gold are being withdrawn, whether it
concerns newly mined gold, scrap gold, bullion gold or coined gold. I dubbed
this event that has cast its long shadow forward for many a year, the last
contango in Washington ― contango being the name for the condition
opposite to backwardation (namely, that of a positive basis), and Washington
being the city where the Paper-mill of the Potomac, the Federal Reserve
Board, is located. This is a tongue-in-cheek way of saying that the jig in
Washington is up. The music has stopped on the players of ‘musical
chairs’. Those who have no gold in hand are out of luck. They
won’t get it now through the regular channels. If they want it, they
will have to go to the black market.
I founded Gold Standard University Live (GSUL) two years ago and dedicated it
to research of monetary issues that are pointedly ignored by universities,
government think-tanks, and the financial press, centered around the question
of long-term viability of the regime of irredeemable currency. Historical
experiments with that type of currency were many but all of them, without
exception, have ended in ignominious failure accompanied with great economic
pain, unless the experiment was called off in good time and the authorities
returned to monetary rectitude, that is, to a metallic monetary standard. It
is also worth pointing out that the present experiment is unique in that all
countries of the world indulge in it. Not one country is on a metallic
monetary standard, under which the Treasury and the Central Bank are subject
to the same contract law as ordinary citizens. They cannot issue irredeemable
promises to pay and keep them in monetary circulation through a conspiracy
known as check-kiting. Not one country will be spared from the fire and
brimstone that once rained on the cities of Sodom and Gomorrah as a punishment
of God for immoral behavior.
In all previous episodes there were some countries around that did not listen
to the siren song and stayed on the gold standard. They could give a helping
hand to the deviant ones, thus limiting economic pain. Today there are no
such countries. If you want to be saved, you must be prepared to save
yourself.
You cannot understand the process whereby a fiat money system self-destructs
without understanding the gold and silver basis. The Quantity Theory of Money
does not provide an explanation, because deflation may well precede
hyperinflation, as it appears to be the case right now.
For these reasons I placed the study of the gold and silver basis on the top
of the list of research topics for GSUL. These can serve as an early warning
system that will signal the beginning of the end. The end is approaching with
the inevitability of the climax in a Greek tragedy, as the heroes and
heroines are drawn to their own destruction. The present reactionary
experiment with paper money is entering its death-throes. GSUL has had five
sessions and could have established itself as an important, and even the
only, source of information about this cataclysmic event: the confrontation
of the Titanic (representing the international monetary system) with the
iceberg (representing gold and its vanishing basis) as the latter is emerging
from the fog too late to avoid collision.
Unfortunately, this was not meant to be: GSUL has to terminate its operations
due to a decision made by Mr. Eric Sprott, of Sprott Asset Management, to
terminate sponsoring GSUL, saying that “results do not justify the
expense.”
I sincerely regret that our activities did not live up to the expectations of
Mr. Sprott, but I am very proud of the fact that our research is still the
only source of information on the vanishing gold basis and its corollary, the
seizing up of the paper money system that threatens the world, as it does,
with a Great Depression eclipsing that of the 1930’s.
Let me summarize the salient points of discussion during the last two
sessions of GSUL for the benefit of those who wanted to attend but
couldn’t. The gold basis is the difference between the futures and the
cash price of gold. More precisely it is the price of the nearby active futures
contract in the gold futures market minus the cash price of physical gold in
the spot market. Historically it has been positive ever since gold futures
trading started at the Winnipeg Commodity Exchange in 1972 (except for some
rare hiccups at the triple-witching hour. Such deviations have been called
‘logistical’ in nature, having to do with the simultaneous expiry
of gold futures and the put and call option contracts on them. In all these
instances the anomaly of a negative basis resolved itself in a matter of a
few hours.)
In the commodity futures markets the terminus technicus for a positive basis
is contango; that for a negative one, backwardation. Contango implies the
existence of a healthy supply of the commodity in the warehouses available
for immediate delivery, while backwardation implies shortages and conjures up
the scraping of the bottom of the barrel. The basis is limited on the upside
by the carrying charges; but there is no limit on the downside as it can fall
to any negative value (meaning that the cash price may exceed the futures
price by any amount, however large).
Contango whereby the futures price of gold is quoted at a premium to the spot
price is the normal condition for the gold market, and for a very good
reason, too. The supply of monetary gold in the world is very large
relatively speaking. Babbling about the ‘scarcity of gold’
reflects the opinion of uninformed or badly informed people. In terms of the
ratio of stocks to flows the supply of gold is far and away greater than that
of any commodity. Silver is second only to gold. It is this fact that makes
the two of them the only monetary metals. The impact on the gold price of a
discovery of an extremely rich gold field, or the coming on stream of an
extremely rich gold mine, is minimal ― in view of the large existing
stocks. Paradoxically, what makes gold valuable is not its scarcity but its
relative abundance, which evokes that superb confidence in the steadiness of
the value of gold that will not be decreased by a banner production year, nor
can it be increased by withdrawing gold coins from circulation. For this
reason there is no better fly-wheel regulator for the value of currency than
gold. The same goes, albeit to a lesser degree, for silver.
Here is the fundamental difference between the monetary metal, gold, and
other commodities. Backwardation will pull in stocks from the moon as it
were, if need be. The cure for the backwardation of any commodity is more
backwardation. For gold, there is no cure. Backwardation in gold is always
and everywhere a monetary phenomenon: it is a reminder of the incurable
pathology of paper money. It dramatizes the decay of the regime of
irredeemable currency. It can only get worse. As confidence in the value of
fiat money is a fragile thing, it will not get better. It depicts the paper
dollar as Humpty Dumpty who sat on a wall and had a great fall and, now,
“all the king’s horses and all the king’s men could not put
Humpty Dumpty together again.” To paraphrase a proverb, give paper
currency a bad name, you might as well scrap it.
Once entrenched, backwardation in gold means that the cancer of the dollar
has reached its terminal stages. The progressively evaporating trust in the
value of the irredeemable dollar can no longer be stopped.
Negative basis (backwardation) means that people controlling the supply of
monetary gold cannot be persuaded to part with it, regardless of the bait.
These people are no speculators. They are neither Scrooges nor Shylocks. They
are highly capable businessmen with a conservative frame of mind. They are
determined to preserve their capital come hell or high water, for saner
times, so they can re-deploy it under a saner government and a saner monetary
system. Their instrument is the ownership of monetary gold. They blithely
ignore the siren song promising risk-free profits. Indeed, they could sell
their physical gold in the spot market and buy it back at a discount in the
futures market for delivery in 30 days. In any other commodity, traders
controlling supply would jump at the opportunity. The lure of risk-free
profits would be irresistible. Not so in the case of gold. Owners refuse to
be coaxed out of their gold holdings, however large the bait may be. Why?
Well, they don’t believe that the physical gold will be there and
available for delivery in 30 days’ time. They don’t want to be
stuck with paper gold, which is useless for their purposes of capital
preservation.
December 2 is a landmark, because before that date the monetary system could
have been saved by opening the U.S. Mint to gold. Now, given the fact of gold
backwardation, it is too late. The last chance to avoid disaster has been
missed. The proverbial last straw has broken the back of the camel.
I have often been told that the U.S. Mint is already open to gold, witness
the Eagle and Buffalo gold coins. But these issues were neither unlimited,
nor were they coined free of seigniorage. They were sold at a premium over
bullion content. They were a red herring, dropped to make people believe that
gold coins can always be obtained from the U.S. Mint, and from other
government mints of the world. However, as the experience of the past two or
three months shows, one mint after another stopped taking orders for gold
coins and suspended their gold operations. The reason is that the flow of
gold to the mints has become erratic. It may dry up altogether. This shows
that the foreboding has been evoked by the looming gold backwardation, way
ahead of the event. Now the truth is out: you can no longer coax gold out of
hiding with paper profits.
If the governments of the great trading nations had really wanted to save the
world from a catastrophic collapse of world trade, then they should have
opened their mints to gold. Now gold backwardation has caught up with us and
shut down the free flow of gold in the system. This will have catastrophic
consequences. Few people realize that the shutting down of the gold trade,
which is what is happening, means the shutting down of world trade. This is a
financial earthquake measuring ten on the Greenspan scale, with epicenter at
the Comex in New York, where the Twin Towers of the World Trade Center once
stood. It is no exaggeration to say that this event will trigger a tsunami
wiping out the prosperity of the world.
References
By the same author:
The Rise and Fall of the Gold Basis, June 23, 2006
Monetary and Non-Monetary Commodities, June 25, 2006
The Last Contango in Washington, June 30, 2006
Gold, Interest, Basis, March,7, 2007
Gold Vanishing into private Hoards, May 31, 2007
Opening the Mint to Gold and Silver, February 5, 2008
These and other articles of the author can be accessed at the website
www.professorfekete.com
Note: the author is coming out with a follow-up piece:
Has the Curtain
Fallen on the Last Contango in Washington?
Stay
tuned.
FOFOA
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