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Here is an update on
the backwardation in gold that started on December 2 at an annualized
discount rate of 1.98% and 0.14% to spot in the December and February contracts.
It continued and worsened on December 8, 9, and 10 as shown by the
corresponding rates widening to 3.5% and 0.65%. It is nothing short of
awesome. This is a premonition of a coming gold fever of unprecedented
dimensions that will overwhelm the world as soon as its significance is fully
digested by the doubting Thomases. The worsening of
backwardation must be viewed in the context of the gold price bouncing back
from the lows of last week. It shows that the ‘gold bashing’ on
Friday was done in the December contract. It is quite revealing that the spot price bounced back more than the
futures price. The bulls are on the warpath. They have unearthed the
hatchet. They have stopped eating from the hands of the clearing members.
Mish Shedlock published a disdainful criticism of my theory on
the worsening backwardation in gold, calling it “nonsense” (see
References below). A friend of his owns a seat on Nymex
(a branch of Comex) who had this to say:
I
have seen countless commodities go into backwardation for numerous reasons,
the most frequent being a radical temporary divergence between immediate and
overall demand. I have seen backwardations that have lasted years. The
article is based on the assumption that a backwardation will necessarily lead
to a breakdown of the delivery mechanism. But for every breakdown of the
delivery
mechanism there have been thousands of
backwardations without a breakdown. Only if and when an actual breakdown
occurred would the conclusions that the author drew make sense.
Well, well, one can
buy himself a seat on the Nymex for sure, and the
price is hefty these days, but Nymex does not
deliver the understanding of monetary science along with the seat. Nor does
any university anywhere in the world. To fill this obvious gap, I founded
Gold Standard University Live. It is defunct today, but not because my
theories are “nonsensical”.
It is defunct because
Mr. Eric Sprott of Sprott
Asset Management withdrew his funding after only three sessions, saying that
“results do not justify the expense”. Under these circumstances I
do what I can to teach all those who want to learn, and pick the
“forbidden fruits” of monetary science that have been blotted out
from the curriculum ― and from the gold and silver pits of Nymex.
Mish says that
“there is nothing special about backwardation, period. OK, they are
rare in gold. So what?” Here is what. There is a difference between
“rare” and “non-existent”. Backwardation in gold has
been non-existent, and for a very good reason, too, as I have explained in my
articles. (I also pointed out that there have been ‘hiccups’,
or short-lived instances of backwardation. They were temporary
‘logistical’ bumps, always resolved within a day at most, and
they never ever spilled over to the next actively traded delivery month.)
Mish needs to educate
himself on the fundamental difference between a monetary and a non-monetary
commodity, before he can grasp the idea that lasting backwardation in gold is
tantamount to the realization that ‘gold is no longer for sale at any
price’.
The bottom line is
that there is no fever like gold fever.
It is akin to St. Vitus’ dance that swept
through the Christian world just before the year 1000 A.D. affecting all the
people who expected the end of the world to happen at the turn of the
millennium. It was far worse than the mania that swept through the world
affecting all the people who expected the 2K disaster to
happen a thousand years later. The coming gold fever must be distinguished
from tulipomania in February 1637, when one single
tulip fetched the equivalent of 20 times the annual income of a skilled
worker. Gold fever is as different from a bubble as real gold is from
fools’ gold. It is visceral. It has to do with one’s instinct for
survival. It has no patience with logical arguments. It is highly contagious,
ultimately affecting everybody. A bubble that never pops.
You may ridicule the
idea that, during a prolonged backwardation, all offers to sell gold will be
withdrawn. But a serious analyst must answer the question why hundreds of
millions of people having gold coins under the mattress and in the cookie jar
refuse to take the bait of ‘risk-free’ profits offered by
backwardation. Such a thing would never
ever happen to a non-monetary commodity.
The only successful
corners in history were gold
corners, a.k.a. hyperinflation. Keynesian and Friedmaite
economists in the pay of the government thought that gold futures trading
will permanently short-circuit the forces of gold backwardation thus
preventing hyper-inflation from ever happening. They were wrong.
In an article The Manipulation of Gold Prices (see
References below), Professor Emeritus of Economics and former Dean of the
School of Business Administration at the University of Indianapolis, James
Conrad argues that Bernanke is different. He understands that he needs a much
higher gold price in order to increase the efficiency of his airdrops. There
is no better way to distribute new money among prospective spenders than
putting it into the pockets of the gold bugs. (Conrad admits that he is one.)
This will induce a large spending spree, holding deflationary pressures back.
According to Conrad,
Bernanke is well aware that the new money he is feverishly airdropping has
not stopped and will probably not stop the bloodbath in the stock market.
Further devastation of share prices will render pension funds insolvent. To
prevent this, the dollar needs a massive devaluation, on the pattern of
Roosevelt’s tinkering with the value of gold. I quote:
Anyone
who reads the written works of our Fed Chairman will know that
Bernanke’s long term plan involves devaluing the dollar against gold.
This is the exact opposite of the position of most prior chairmen. He has
overtly stated his intentions toward gold, many times, in various articles,
speeches and treatises written before he became Fed Chairman. He often extols
the virtues of F. D. Roosevelt’s gold revaluation/dollar devaluation
back in 1934, and credits it with saving the nation from the Great
Depression. According to Bernanke, devaluation of the dollar against gold was
so effective in stimulating economic activity that the stock market rose sharply in 1934, immediately thereafter. That is
something that the Fed wants to see happen again.
It
is only a matter of time before gold is allowed to rise to its natural level.
Assuming that about one half of the recent increase in Federal Reserve credit
is neutralized, the monetized value of gold should be allowed to rise to
between $7,500 and $9,000 per ounce as the world goes back to some type of a
gold standard. In the nearer term, gold will rise to about $2,000 per ounce
as the Fed abandons its hopeless campaign to support Comex
short sellers in favor of saving the other, more productive, functions of
various banks and insurers.
Revaluation
of gold, and a return to a gold standard, is the only way that hyperinflation
can be avoided while large numbers of paper currency units are released into
the economy. This is because most of the rise in prices can be filtered into
gold. As the asset value of gold rises, it will soak up excess dollars, euros, pounds, etc., while the appearance of an increased
number of currency units will stimulate investor psychology; and lending and
economic output will increase all over the world. Ben Bernanke and the other
members of the FOMC Committee must know this, because it is basic economics.
It is to be regretted
that more of Professor Conrad’s admirable paper cannot be quoted here
because of lack of space. To summarize: Bernanke is prepared to throw the
issuers of paper gold at the Comex to the wolves,
as they have become useless, even a nuisance, by now. Besides, the wolves
must be appeased lest they devour whatever remains of the U.S. banking and
insurance system.
My own position is
somewhat different from Professor Conrad’s. In my view we are facing a
world-wide elemental grass-root movement: the flight into physical gold ― witness the backwardation in
gold. It is irresistible, and will ultimately overtake all other market
forces. It will overwhelm official resistance.
An intriguing case can
be made, as is attempted by Conrad, that Bernanke is intelligent enough to
realize all this thinking that he can harness, if not hijack, the grass-root
movement for his own purposes. This is a wee-bit more intelligence than I can
give credit for to the Chairman, who is a former
academic himself. I find the thought surrealistic that Bernanke wants to use
gold as the safety-valve through which he can release steam from an
overheating deflation one day, and from an overheating inflation the next.
Be that as it may, the
Brave New World of irredeemable currency sans
the paper gold factory at Comex will be an entirely
different world from what we have been used to for the past thirty-six years.
I highlight the differences as I see them. This should be helpful in the long
run, even if this backwardation is temporary and gold futures trading will
return to normal, since permanent backwardation is ultimately unavoidable.
Item
1:
Barrick and other gold producers that still have an
open hedge book will go bankrupt.
Item
2:
Other gold miners will, one after another, stop selling gold altogether, and
go into hibernation.
Item 3: Junior gold mines will put off
starting production indefinitely. They will consider their gold ore reserves
in the ground a safer store of value than paper money in an insolvent bank.
Item
4:
The closing of the gold window at the Comex will
furnish an excuse for other issuers of paper gold including the bullion banks
to declare bankruptcy fraudulently.
Item
5:
GLD and other joint depositories of gold will be under enormous pressure to
default and let the owners of the ETF shares hold the bag. Let them sue for
the gold. They won’t get it: their contracts give them no right to physical gold. They will get small change, in paper. The principals
will cut up the gold pie among themselves. No crumbs will trickle down to
shareholders.
Item
6:
Even allocated and segregated metal account gold is not safe. The temptation
on the account providers to default will be irresistible. They are not going
to release the gold until expressly ordered by the courts, and will make sure
that no gold will be left by then.
Item
7:
Central banks forfeit their gold under leases due to backwardation, causing an uproar of citizens whose patrimony was sequestered and
dissipated in such an ignominious manner.
Item
8:
The only market for gold will be the fragmented black markets in various countries
each charging a price whatever the traffic can bear. All legal protection of
the ownership of and trade in gold will be suspended. The Dark Age will
descend on the trading world, just as it did when the Roman Empire collapsed.
Our
present experiment with irredeemable currency can last only as long as it is
able to support futures markets in gold. The declining gold basis is the hour
glass: when it runs out and the last grain of sand drops, gold fever will
bleed the futures markets of cash gold, and the days of the regime of
irredeemable currency are numbered.
Previous episodes of
experimentation lasted no more than 18 years, or
half as long as the present one which has taken 36 years so far, a world
record. Of course, none of the earlier episodes were supported by futures
markets. Forewarned, forearmed. Get ready and move closer to the doors. When
the curtain falls on the last contango in
Washington, there will be panic and some people may get trampled to death at
the exit.
Dear Mish, lower your
gun. The topic of gold backwardation is not for you.
References
Monetary versus Non-monetary Commodities, April 25, 2006
The Last Contango in Washington, June 30,
2006
Red Alert: Gold Backwardation!!! December 4, 2008
Has the Curtain Fallen on the Last Contango
in Washington? December 8, 2008
These and other articles of the author can be
accessed at the website
www.professorfekete.com
The Nonsense about Gold Backwardation, etc., by Mike (Mish) Shedwick, December 7, 2008, www.globaleconomicanalysis.blogspot.com
The Manipulation of Gold Prices, by James Conrad, December 4, 2008, www.seekingalpha.com
Gold in Backwardation? Not so fast…, by ‘Hard Asset
Investor’, December 2, 2008, ibid.
The Battle against Contango, by Brad Zigler, November 20, 2008,
www.hardassetsinvestor.com
Calendar of events
Szombathely, Martineum Academy, Hungary, March 28-29, 2009
Encore Session of Gold
Standard University Live.
Topics: When Will the Gold Standard Be Released
from Quarantine?
The
Vaporization of the Derivatives Tower
Labor and the Unfolding
Great Depression
Gold
and Silver in Backwardation: What Does It All Mean?
San Francisco School of Economics, June-August, 2009
Money
and Banking, a ten-week course based on the
work of Professor Fekete.
The Syllabus
of this course is can be seen on the website:
www.professorfekete.com
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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