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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
Antal E. Fekete
Professor, Intermountain
Institute of Science and Applied Mathematics, Missoula, MT 59806, U.S.A.
Gold Standard University
aefekete@hotmail.com
DISCLAIMER AND CONFLICTS
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.
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