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There continues to be
no sustained backwardation in gold according to my proprietary measures, my
primary indicators, or the publicly-available data such as the LBMA
forward rates or the quoted COMEX futures prices. Once again, this does not
make the Professor’s recent commentaries wrong because there is clearly
an undercurrent of demand in the physical gold market tied to monetary
forces. This undercurrent was first manifested in the rabid retail bullion
demand that sprang up earlier this year and it has been consistently moving
toward the wholesale market. I was one of the first to discuss this, see: The Danger of a Retail-Led Silver Revolution.
We’ve come quite a ways since then with the latest
“revolution” being a concerted effort to take large deliveries in
December gold and silver on the COMEX. In any case, it is more important than
ever to monitor the basis for signs that the monetary forces are
increasingly favorable to gold. So far they are but it is by no means certain
that we’ve passed the point of no return.
Before providing an
update on the basis, please allow me to go over a few items for
clarification:
(1) For purposes of
gold backwardation preceding monetary collapse, local prices such as those in
India are irrelevant. We only need to look at prices where the vast
majority of buying volume occurs — London and New York. Many
people claim that New York and London gold and silver prices can be
easily distorted by outside factors, but the truth is that local prices are
much more likely to be distorted. If you want to study gold and silver as
monetary phenomena, you need to utilize the prices in New York and London where the money is.
(2) Interest rates
have continued to fall this week with short-term Treasury bills actually
going negative into “interest rate backwardation”. In addition,
even the short end of the LIBOR curve has collapsed in the past few days. In
light of this, let me repeat that gold and silver contango, and thus
backwardation, are highly sensitive to interest rates, much more so than any
commodity. If somehow short-term interest rates were to go into significant
backwardation, it should be no surprise that gold and silver may also go into
significant backwardation. THIS WOULD NOT BE A SIGN OF IMMINENT MONETARY
COLLAPSE. In fact, a pretty strong argument can be made for the
opposite–that the negative interest rate is a sign of excessive (in
relation to demand for capital goods and investments) monetary demand.
I’ve looked but have been unsuccessful in finding a historical example
of a monetary collapse that occurred while money was actually in high demand.
Of course, high demand for money can be extremely deflationary and the only
known cure for this is to create a high supply of money, otherwise known as
hyperinflation.
(3) The spot gold and
silver price are somewhat elusive because they are not based on actual trades
that occur on a regulated exchange. Rather, spot prices are third-party
quotes that suffer from a variety of problems that can make them unreliable
or imprecise. Therefore it is very easy to make basis calculation
errors. This is especially true considering that the basis is a fractional
number. During the past few years, there have been literally thousands of
instances where gold and silver appeared momentarily to be in
backwardation. The next moment, however, the basis had returned to a healthy
contango in the range of 3-4% annualized. Currently the gold basis is in very
slight contango (and silver may actually be flirting
with backwardation) as a result of some combination of low
interest rates and wholesale demand, so it is not at all
unusual that there would be more frequent moments when gold and silver
appear to be in backwardation. In other words, the jury is still out.
(4) Historically,
gold and silver have been in consistent backwardation on a closing basis for
a number of trading days in a row, not just fleeting moments. These periods
of backwardation resulted from one-off events that dissipated rather
quickly and had nothing to do with interest rates being near zero. The reason
I bring up interest rates again is that should they stay near zero for a
substantial period of time, we would expect that gold and silver
may also hover near or even trade slightly into backwardation for a
substantial period of time. In other words, there is historical precedent for
neither extended near-zero interest rates nor extended
near-backwardation gold. In any case, gold was near or
in backwardation during February to May 1975, November to
December 1975, January to April 1976, August to October 1976, May 1977,
November 1978, January 1980, March to May 1980, January 1981, November 1981,
July 1985, November 1992, January 1993, etc., you get the picture.
(5) It
is incorrect to claim that gold and silver could be in true
backwardation without at least some inversion of the futures price curve
where the nearer contracts are trading at a higher price than the further out
contracts. Not every contract needs to be in backwardation, but there should
be at least one pair in backwardation. This may seem confusing since the
backwardation we are looking for is between the spot price and the futures
prices, not between two different futures prices, but it turns out that the
basis exists as a continuum and not simply as a concept suspended in space
and time. Simply put, a lack of any backwardation in the progression of
futures prices means that the basis continuum is broken and thus calls for
backwardation are at best early and at worst presumptuous. No, it is not
different this time.
(6) A claim of
backwardation without specific, verifiable data to prove it is not
very valuable. My prior post included a comparison between the active gold
COMEX contract and the Kitco spot price for the dates December 3-5 (I was
unable to go back to December 2 so it is possible that the chart would have
looked different on that date but not very likely). If there was a
discernable backwardation in gold, this type of chart would indicate it.
I’ve updated the chart for today below.
(7) As I’ve
already noted, it is pointless to use the December COMEX contract for
basis calculation because trading volume is too light. If you are fortunate
enough to have tick-level data for both December COMEX gold and spot
gold, perhaps you can make some comparisons but it still would be a shot in
the dark. Besides, December COMEX gold after the first delivery date is
already essentially the same thing as New York spot gold, so what spot price
is the December futures contract being compared to? If it is the Kitco
spot price or other “third party” price, then you are not
calculating the basis between futures and spot but rather between two
different spot prices (New York and London). While there may be a valid
purpose in calculating the basis between two spot prices, it is of limited
value.
(8) When it comes to
backwardation, it is very important to understand that we are talking about
fractional amounts so precision is quite important. Single data points and ad
hoc “observing the markets” are meaningless unless
they reveal price extremes that are being consistently repeated for a
period of time. What’s important is repeated, verifiable trades
that are all occurring in backwardation, and more and more so. Alas, I see no
sign of any such developing pattern up to this point although silver bears
close watching.
I have no idea where
Professor Fekete is getting his numbers as he did not check
with me, and I did not expect him to check with me, before
publishing his commentaries. I am reporting on what I see and what I know
and couldn’t care less about presenting a “unified
front” or ”getting our stories straight”.
Thus, I cannot
comment quantitatively on the Professor’s latest article There
Is No Fever Like Gold Fever other than to state my basis data says
something else. I do, however, have some qualitative comments. First, what he
says about the fundamental meaning of backwardation in gold is absolutely
correct. He may be early in his call and he may need to take into account the
near-zero “risk free” interest rate on short-term debt, but
he is deadly right that backwardation, should it become entrenched,
would herald the monetary ascendance of gold. At the same time, I don’t
see things evolving in the same catastrophic manner that he does. For
example, I believe there will always be willing buyers and sellers of gold in
some quantity if the price is right such that there won’t really be
universal hoarding that leads to a cessation in gold mining, loss of
segregated metal deposits, and institutionalized theft of ETF holdings. I
also don’t believe that the gold futures markets will go
away–they will merely be marginalized. Or perhaps they
will become either cash settled or an outright cash
market.
Second, I note that
the Professor seems to be in agreement with the idea that under the
circumstance where gold is “allowed” to appreciate in a
hyperinflationary scenario, it may be technically possible to delay the
collapse of the fiat monetary system. Indeed, this may be why an
incipient backwardation in gold could indicate that much higher prices
may lie ahead. And yes, a continued move toward or into backwardation
that coincides with a major rally might mean that gold is
entering the ”fever” phase where it regains
fully-recognized monetary status. My personal opinion, however, is
that such a phase or rather phases could last for many years and
therefore claims of imminent monetary and economic collapse will likely prove
yet again to be wrong. In more descriptive terms, the Last Contango in Washington could turn out to be a very long, and at times boring, dance.
While gold is not in
backwardation at this time, some mild backwardation appears to be
forming in silver over the past few days. The following are the
LBMA forward rates for 1, 2, 3, 6 and 12 months in silver for this week:
08-Dec-08 -0.011
0.013 0.021 0.200 0.330
09-Dec-08 -0.071 -0.057 -0.051 0.174 0.235
10-Dec-08 -0.081 -0.054 -0.028 0.164 0.297
11-Dec-08 -0.108 -0.058 -0.041 0.091 0.305
12-Dec-08 -0.091 -0.041 -0.025 0.108 0.291
Note the negative
forward rates on the 1, 2 and 3 month maturities. We must, however, view this
in terms of interest rates as discussed in my last posting, which have been
falling and falling this week to record lows on the short end of the yield
curve. Here are the LIBOR rates (1, 2, 3, 6 and 12 months) according to the
LBMA website:
08-Dec-08 1.836 2.021 2.167
2.400 2.465
09-Dec-08 1.706 2.049 2.215 2.350 2.474
10-Dec-08 1.520 1.958 2.127 2.273 2.325
11-Dec-08 1.303 1.825 2.037 2.230 2.223
12-Dec-08 1.131 1.722 1.946 2.111 2.127
Note that LIBOR is
down substantially with the shortest maturity rate literally
collapsing to around 1% today. LIBOR of course is not a risk-free rate
since it is the rate that banks charge each other, but it appears the
government bailouts and guarantees have made people (or at least bank
managers) believe that LIBOR is nearly risk-free.
Now let’s look
at the COMEX silver futures. We had the following close yesterday
(December 11):
Contract Last Change
Open High Low
$Cash 10.367 +0.131 10.237 10.537 10.137
Dec08 10.390 +0.225 10.120 10.445 10.120
Jan09 10.390 +0.225 10.205 10.460 10.190
Feb09 10.408 +0.225 10.470 10.470 10.395
Mar09 10.425 +0.225 10.220 10.540 10.130
May09 10.445 +0.224 10.285 10.510 10.285
Clearly there is
still a mild forward price progression in the futures representing
contango except that the spot month December contract closed at the same
price as the January 2009 contract, which seems to indicate that COMEX silver
is on the verge of backwardation. Then again, look at the high and low for
the day. From that angle, the December contract was still comfortably in
contango. Also, consider that the December contract traded volume was 42,
January was 52 and February was 4 compared to 15,211 for March. Such light
volume means that the quoted prices, even the intra-day highs and lows,
in the December, January and February contracts are largely meaningless.
To determine whether
or not silver was in backwardation yesterday or today, it would be
most appropriate to use the March 2009 COMEX contract. Once again,
let’s prepare a chart overlay as that is probably the best way to
evaluate the present situation. Below is the Kitco spot silver price and the
March 2009 COMEX contract for Thursday, December 11.
Well, all we can say
about this chart is that there appears to be a few moments when the
silver price is in backwardation but in general we are still seeing the
bars (representing the March 2009 COMEX futures) riding on top of the red
line (the December 11 spot price). As such, there is no confirmed
backwardation in silver despite the negative forward rates published by
the LBMA.
Let’s examine
today to see if there is anything different going on:
Looks like the bars
are a bit closer to the line and the futures even seem to
be spending more time below the spot price especially during periods of
large price moves but this is still not what true backwardation looks like.
Close is not enough. After all, we are not talking about horseshoes or hand
grenades.
Let’s finally
look at gold today. I’m using February 2009 since once again there
is not sufficient trading volume left in the December contract:
The above
chart is for those of you who may complain that comparing bars to
lines is too hard. Here, I’m using the 5-minute closing prices of
the COMEX February 2009 gold contract. It is plainly visible
that gold was not in backwardation today according to this measure.
Finally, below
is an overlay between the December 2008 (which is a proxy for the spot price
after December 1) and the February 2009 gold contracts. The darker line
is the February 2009 contract and the lighter line is December 2008. Although
these are daily closing prices, some degree of backwardation should be
apparent on this chart if gold has in fact been in backwardation with
any degree of consistency during the past two weeks. That is obviously
not the case.
Going forward, I will
be plotting these and other graphs as part of the Metal Augmentor service on
at least a weekly basis and probably more often as conditions warrant. If you
are a subscribing Founding Member and do not receive an email update
about the service in the next few days (some emails have been blocked in
the past), please contact me so I can send you the details directly.
Tom Szabo
Silveraxis.com
Tom Szabo introduces The Metal Augmentor, which will be the detailed coverage of mining equities from junior
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