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The
scramble for physical gold and silver is intensifying. People increasingly
want to own the real thing, and not some paper substitute, all of which come
with counterparty risk. This conclusion is apparent from the following
two charts of gold and silver forwards, which are based on data made
available by the London
Bullion Market Association through
November 24th (the most recent data available).
Because
gold is money, gold almost always trades in contango,
meaning the future price is higher than the spot price. The percentage
difference between gold’s spot and future price is gold’s interest
rate, so in this regard, gold is not different from other moneys, except
gold’s interest rate is lower than those of national currencies.
Interest rates are a reflection of risk, and because gold’s purchasing
power cannot be debased by central bank or government actions, the risk of
losing purchasing power when holding gold is low. So gold is rewarded
by the market with a low interest rate.
If the
future price is lower than spot, which is called backwardation, you can sell your
metal in the spot market, invest the dollars you receive to earn interest,
and then buy your metal back in the future at a lower price and profit the
difference. But there is another important factor to consider outside
the math of this formula.
If you sell
your physical metal in the spot market and at the same time agree with
someone to buy it back at a future date, you are now holding someone’s
paper promise instead of physical metal. In other words, you have
counterparty risk, which of course is avoided when you own a tangible asset
like physical gold or physical silver.
Normally,
few people worry about counterparty risk. So bullion dealers and other
institutions dealing in the precious metals watch for opportunities to profit
from backwardation, with the result that gold rarely, if ever, trades in
backwardation, which explains why the above chart is so extraordinary.
Gold for
1-month and 3-months forward has been mainly in backwardation for more than
one year. Even more exceptional is that gold 6-months forward has been
in backwardation since November 5th. To show how rare this event is, I
checked the LBMA database, which goes back to 1989. There is not one
instance of 6-month forward gold being in backwardation, which nearly confirms
my own experience. I’ve been trading the precious metals since
the 1970s, and I can’t recall any time before this year when 6-months
forward gold was in backwardation. The current and continuing
backwardation is truly incredible.
Note too the clear downtrend in 12-month forward gold which is
approaching backwardation, which is similar to the downtrends for other
forward periods. These downtrends make clear that the demand for
physical gold is intensifying.
The picture
is even starker in silver. Not only are its forwards also in clear
downtrends, silver 6-months forward has been continuously in backwardation
since June 2nd and mainly in backwardation for more than one year. What
does it all mean?
In a word,
it is bullish. The only way the increasing demand for physical metal
can be met is with higher prices. The higher price will at some level
entice people to sell their metal and hold a national currency instead, as I
explained in my previous article, The Precious
Metals Power Higher.
Some
skeptics may argue that gold is in backwardation because dollar interest
rates are so low, which does have an element of truth to it. This
argument though ignores that dollar rates have been low since shortly after
the Lehman collapse, which is months before the backwardation began to
appear. Also when the Greenspan-led Fed lowered dollar interest rates
after 9-11 to near-zero levels, no backwardation appeared.
Skeptics
might also argue that there is no backwardation apparent from Comex settlement prices. Aside from the fact that Comex recently changed the method to determine settlement
prices from a market-driven basis to instead allow a manual override, which
now makes backwardation on the posted Comex
settlement prices virtually impossible, one has to first recognize that Comex is first and foremost a market for paper-gold and
paper-silver. Therefore, a piece of paper can promise virtually
anything, without regard to the underlying reality of how physical metal is
actually trading. In other words, Comex shows
March futures in contango, when they should in
reality be in backwardation. Thus, if you are buying March silver or
April gold futures, you are overpaying. This overpayment is no doubt
going into the pockets of those banks that are perennially short and use
their size to control the paper market. They can, after all, always
conjure up whatever paper they want out of thin air, which of course they
cannot do with physical metal.
Any way you
look at it, the backwardation in gold and silver is a truly rare event and an
exceptionally bullish one too. So be prepared for an upside explosion
in the price of both precious metals as the scramble for physical metal
intensifies even further as a result of people increasingly choosing to hold
a safe-haven tangible asset instead of paper.
James Turk
Free Gold Money
Report
Article originally published by the Free
Gold Money Report.
James Turk is the
founder of the Free Gold Money Report and of GoldMoney.com. He is also the
co-author of The Coming Collapse of the Dollar (www.dollarcollapse.com).. Copyright
© by James Turk. All rights
reserved.
Copyright © 2008. All rights reserved.
Edited by James Turk
This material is prepared for general circulation and may not have
regard to the particular circumstances or needs of any specific person who
reads it. The information contained in this report has been compiled from
sources believed to be reliable, but no representations or warranty, express
or implied, is made as to its accuracy, completeness or correctness. All
opinions and estimates contained in this report reflect the writer's
judgement as of the date of this report, are subject to change without notice
and are provided in good faith but without legal responsibility.
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