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I
have received a deluge of mail from readers of my latest article on the gold
basis and the threat of the coming permanent backwardation in gold. I truly
appreciate the interest of my readers in learning my thoughts on the subject.
I regret that it is not possible for me to answer these letters individually;
I make an attempt here to answer one or two, where the questions are general
enough so that my answers may benefit all readers.
. . .
Hello, Antal:
I have questions about your "Dress
Rehearsal for the Last Contango."
1) Will not gold at +$1,000 per ounce
restore gold holdings registered at Comex warehouses? If not, why not?
2) When the gold basis goes negative,
could it not subsequently go back to positive, assuming the price rises to
over $1,000? If not, why not?
3) Why must gold backwardation, once
established, become permanent?
I should like to hear your reply to
these questions. I am really very interested in understanding fully the
implications of the vanishing basis for gold, and I hope you can provide me
with your answers to my questions.
With warm regards,
Victor
. . .
Dear Victor:
For a full discussion on the gold basis
and the permanent backwardation in gold you must come to Canberra, Australia,
where the Gold Standard Institute will have a seminar in November. This
seminar is second devoted exactly to these topics. Last year's seminar was a
great success; this year's will be an even greater one.
I am confident to say that Canberra is
the only place in the world where you may get scientific information on gold
contango, gold basis, gold warehousing, bimetallic arbitrage, and the prospects
of permanent gold backwardation as well as answer to a host of tantalizing
questions that arise from these.
We shall have an expert on hand from the
Perth Mint. And as an absolute first, we shall have the manager of Masters
Fund, a unique gold fund just coming on stream, to answer questions. I am
proud to say that I have been associated with this fund from inception
throughout the incubation period. The Masters Fund is offering exclusive
features not available from any other fund, such as:
1) The guiding star of the fund is not
the dollar price of gold, but the gold basis which is much less open to
manipulation, and much more relevant to an accumulation plan.
2) The gold in the fund bears a return
in gold, so profits are measured not in terms of the U.S. dollar but in terms
of gold itself.
3) Any appreciation of the fund's value
in U.S. dollar terms is additional, but the maximization of dollar value is
not a prime objective.
4) The gold in the fund is never put out
on lease or on loan, nor can it be pledged as collateral, but stays on the
premises at all times under the full control of the fund. It has never
happened before that you could collect the return on capital unless you were
willing to relinquish temporary control over it and thereby assume the risk
of losing it. This could be important at a time when wholesale defaults on
paper gold contracts may engulf the world.
5) The principle on which the fund
operates is valid whether the monetary metals are in a bull market or a bear
market.
6) The fund is especially recommended to
those individuals who are in the habit of measuring the value of their assets
and their own net worth in gold units rather than irredeemable paper units
such as the US dollar.
7) The fund is structured in such a way
as to take full advantage of the coming permanent gold backwardation, when
all other gold funds will be grounded.
Of course false alarms can and do occur,
and it is possible that gold goes into backwardation and then promptly comes
out of it. It has happened before. But we are looking at a 35-year trend,
embracing the entire history of gold futures trading. The trend has been
that, as a percentage of the prevailing rate of interest, the basis has been
falling from practically 100 percent to practically 0 percent.
You and I know the reason for this. It
has to do with the vanishing of all newly mined gold into private hoards at
an accelerating pace, the insatiable appetite in the world to snap up all
available gold by well-heeled governments and individuals who no longer
believe in the tooth fairy residing in the Federal Reserve.
You have to remember that the basis is
widely used as a guide in the huge arbitrage operations between gold holdings
and dollar balances and in the gold carry trade. To participate in this arbitrage
you must have gold on deposit in Comex warehouses. But with the vanishing of
the gold basis the profitability of this arbitrage as well as that of the
gold carry trade has been drying up, which explains the dwindling of
warehouse stocks.
Another consequence of the vanishing of
the gold basis is that it makes the risks involved in the gold/paper
arbitrage rather lopsided, as far greater risks are assigned to short
positions on gold and long positions on the dollar than on long positions on
gold and short positions on the dollar. The arbitrageurs are very much alive
to this lack of symmetry and are increasingly unwilling to put their gold in
harm's way. They are fully aware that we are approaching an historic
milestone, one that has never been passed before: the milestone marking the
last contango.
As a consequence of this lopsidedness
the gold futures markets can no longer coax gold out of hiding. In vain do
futures markets promise risk-free profits for taking over the carry from the individual.
Here is the deal they offer you: Give us
your cash gold in exchange for gold futures that we'll let you have at a deep
discount so that you can pocket risk-free profits. The offer is increasingly
declined. There was a time when a drop in the basis would pull in gold from
the moon, figuratively speaking. No more. Arbitrageurs no longer believe that
gold futures are fully exchangeable for cash gold.
Gold backwardation is virtually
inevitable, and when it comes, it will be irreversible. Why? Because it
signifies a crisis of the first magnitude: the general disappearance of gold
from trade for reasons of lack of confidence. No one will give up gold,
because one is no longer confident that he can get it back on the same terms.
Vanishing confidence is like a runaway
train The only thing that might turn this runaway train around is a steep
rise in US interest rates. However, this is not in the cards. It would ruin
what is left of the US economy. It would also cause the bond market to
collapse, sending the dollar down the drain.
I do not see the collapse of the bond
market happening any time soon. The US Treasury and the Federal Reserve can
muddle through this crisis, and possibly beyond, by making bond speculation
risk-free in order to maintain demand for Treasury paper.
Having said that, I don't think the guys
at the US Treasury and Federal Reserve understand the gold basis and the
seriousness of the threat of permanent gold backwardation. They are just
trying to hold the line at $1,000 for whatever psychological value it may
have, for as long as they can. It's the same old tug of war, they think.
It is not. Once the $1,000 level is
breached, there may be some "profit taking," to be sure. But
because of the zero basis, those who take profits
will look rather foolish. Last contango -- last profit taking.
Be prepared for a great wave of defaults
on paper gold obligations. Certainly, the lessees of central bank gold will
default. Comex will close its gold pit for good, and outstanding contracts
will be settled on a cash basis.
I will be surprised if any gold ETF
shareholders will see a grain of gold coming their way out of the rubble left
by the default. Comex gold certificate holders will be lucky if they can get
a fraction of their gold back from the warehouses -- after a lengthy wrangle.
Too many claims have been issued on the same lump of gold.
Under
these circumstances it is difficult to see how anyone could wish to deposit
gold in a Comex warehouse to restart gold futures trading. The market for slaves
disappeared after emancipation never to come back again. The gold futures
markets will disappear, utterly (and deservedly) discredited. Like the slave markets, they will never come
back.
Antal E. Fekete
San Francisco School
of Economics
aefekete@hotmail.com
Read
all the other articles written by Antal E. Fekete
DISCLAIMER
AND CONFLICTS
THE PUBLICATION OF THIS LETTER IS FOR YOUR INFORMATION AND AMUSEMENT ONLY.
THE AUTHOR IS NOT SOLICITING ANY ACTION BASED UPON IT, NOR IS HE SUGGESTING
THAT IT REPRESENTS, UNDER ANY CIRCUMSTANCES, A RECOMMENDATION TO BUY OR SELL
ANY SECURITY. THE CONTENT OF THIS LETTER IS DERIVED FROM INFORMATION AND
SOURCES BELIEVED TO BE RELIABLE, BUT THE AUTHOR MAKES NO REPRESENTATION THAT
IT IS COMPLETE OR ERROR-FREE, AND IT SHOULD NOT BE RELIED UPON AS SUCH. IT IS
TO BE TAKEN AS THE AUTHORS OPINION AS SHAPED BY HIS EXPERIENCE, RATHER THAN A
STATEMENT OF FACTS. THE AUTHOR MAY HAVE INVESTMENT POSITIONS, LONG OR SHORT,
IN ANY SECURITIES MENTIONED, WHICH MAY BE CHANGED AT ANY TIME FOR ANY REASON.
Copyright
© 2002-2008 by Antal E. Fekete - All rights reserved
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