Best of the Week
Most Popular
1. US Housing Market Real Estate Crash The Next Shoe To Drop – Part II - Chris_Vermeulen
2.The Coronavirus Greatest Economic Depression in History? - Nadeem_Walayat
3.US Real Estate Housing Market Crash Is The Next Shoe To Drop - Chris_Vermeulen
4.Coronavirus Stock Market Trend Implications and AI Mega-trend Stocks Buying Levels - Nadeem_Walayat
5. Are Coronavirus Death Statistics Exaggerated? Worse than Seasonal Flu or Not?- Nadeem_Walayat
6.Coronavirus Stock Market Trend Implications, Global Recession and AI Stocks Buying Levels - Nadeem_Walayat
7.US Fourth Turning Accelerating Towards Debt Climax - James_Quinn
8.Dow Stock Market Trend Analysis and Forecast - Nadeem_Walayat
9.Britain's FAKE Coronavirus Death Statistics Exposed - Nadeem_Walayat
10.Commodity Markets Crash Catastrophe Charts - Rambus_Chartology
Last 7 days
Could Gold Price Reach $7,000 by 2030? - 6th Aug 20
Bananas for All! Keep Dancing… FOMC - 6th Aug 20
How to Do Bets During This Time - 6th Aug 20
How to develop your stock trading strategy - 6th Aug 20
Stock Investors What to do if Trump Bans TikTok - 5th Aug 20
Gold Trifecta of Key Signals for Gold Mining Stocks - 5th Aug 20
ARE YOU LOVING YOUR SERVITUDE? - 5th Aug 20
Stock Market Uptrend Continues? - 4th Aug 20
The Dimensions of Covid-19: The Hong Kong Flu Redux - 4th Aug 20
High Yield Junk Bonds Are Hot Again -- Despite Warning Signs - 4th Aug 20
Gold Stocks Autumn Rally - 4th Aug 20
“Government Sachs” Is Worried About the Federal Reserve Note - 4th Aug 20
Gold Miners Still Pushing That Cart of Rocks Up Hill - 4th Aug 20
UK Government to Cancel Christmas - Crazy Covid Eid 2020! - 4th Aug 20
Covid-19 Exposes NHS Institutional Racism Against Black and Asian Staff and Patients - 4th Aug 20
How Sony Is Fueling the Computer Vision Boom - 3rd Aug 20
Computer Gaming System Rig Top Tips For 6 Years Future Proofing Build Spec - 3rd Aug 20
Cornwwall Bude Caravan Park Holidays 2020 - Look Inside Holiday Resort Caravan - 3rd Aug 20
UK Caravan Park Holidays 2020 Review - Hoseasons Cayton Bay North East England - 3rd Aug 20
Best Travel Bags for 2020 Summer Holidays , Back Sling packs, water proof, money belt and tactical - 3rd Aug 20
Precious Metals Warn Of Increased Volatility Ahead - 2nd Aug 20
The Key USDX Sign for Gold and Silver - 2nd Aug 20
Corona Crisis Will Have Lasting Impact on Gold Market - 2nd Aug 20
Gold & Silver: Two Pictures - 1st Aug 20
The Bullish Case for Stocks Isn't Over Yet - 1st Aug 20
Is Gold Price Action Warning Of Imminent Monetary Collapse - Part 2? - 1st Aug 20
Will America Accept the World's Worst Pandemic Response Government - 1st Aug 20
Stock Market Technical Patterns, Future Expectations and More – Part II - 1st Aug 20
Trump White House Accelerating Toward a US Dollar Crisis - 31st Jul 20
Why US Commercial Real Estate is Set to Get Slammed - 31st Jul 20
Gold Price Blows Through Upside Resistance - The Chase Is On - 31st Jul 20
Is Crude Oil Price Setting Up for a Waterfall Decline? - 31st Jul 20
Stock Market Technical Patterns, Future Expectations and More - 30th Jul 20
Why Big Money Is Already Pouring Into Edge Computing Tech Stocks - 30th Jul 20
Economic and Geopolitical Worries Fuel Gold’s Rally - 30th Jul 20
How to Finance an Investment Property - 30th Jul 20
I Hate Banks - Including Goldman Sachs - 29th Jul 20
NASDAQ Stock Market Double Top & Price Channels Suggest Pending Price Correction - 29th Jul 20
Silver Price Surge Leaves Naysayers in the Dust - 29th Jul 20
UK Supermarket Covid-19 Shop - Few Masks, Lack of Social Distancing (Tesco) - 29th Jul 20
Budgie Clipped Wings, How Long Before it Can Fly Again? - 29th Jul 20
How To Take Advantage Of Tesla's 400% Stock Surge - 29th Jul 20
Gold Makes Record High and Targets $6,000 in New Bull Cycle - 28th Jul 20
Gold Strong Signal For A Secular Bull Market - 28th Jul 20
Anatomy of a Gold and Silver Precious Metals Bull Market - 28th Jul 20
Shopify Is Seizing an $80 Billion Pot of Gold - 28th Jul 20
Stock Market Minor Correction Underway - 28th Jul 20
Why College Is Never Coming Back - 27th Jul 20
Stocks Disconnect from Economy, Gold Responds - 27th Jul 20
Silver Begins Big Upside Rally Attempt - 27th Jul 20
The Gold and Silver Markets Have Changed… What About You? - 27th Jul 20
Google, Apple And Amazon Are Leading A $30 Trillion Assault On Wall Street - 27th Jul 20
This Stock Market Indicator Reaches "Lowest Level in Nearly 20 Years" - 26th Jul 20
New Wave of Economic Stimulus Lifts Gold Price - 26th Jul 20
Stock Market Slow Grind Higher Above the Early June Stock Highs - 26th Jul 20
How High Will Silver Go? - 25th Jul 20
If You Own Gold, Look Out Below - 25th Jul 20
Crude Oil and Energy Sets Up Near Major Resistance – Breakdown Pending - 25th Jul 20
FREE Access to Premium Market Forecasts by Elliott Wave International - 25th Jul 20
The Promise of Silver as August Approaches: Accumulation and Conversation - 25th Jul 20
The Silver Bull Gateway is at Hand - 24th Jul 20
The Prospects of S&P 500 Above the Early June Highs - 24th Jul 20
How Silver Could Surpass Its All-Time High - 24th Jul 20

Market Oracle FREE Newsletter

How to Get Rich Investing in Stocks by Riding the Electron Wave

Futures Markets Signal Gold Price Ready To Erupt

Commodities / Gold and Silver 2013 Aug 09, 2013 - 06:08 PM GMT

By: Peter_Schiff

Commodities

With gold recouping some losses in its most recent trading sessions, many are asking whether or not the bottom has finally formed for the yellow metal. Most of these gains have been simply chalked up to short-covering and dovish remarks by Bernanke during the recent Federal Open Market Committee meetings; however, there are some key indicators for gold which are overshadowed by the media hubbub. Two of them in particular are important to understand, because they reveal a renewed investment demand for physical gold over paper gold or fiat currencies.


Gold Backwardation
The first indicator to note is called "gold backwardation," which occurs "when the price of a futures contract is lower than the price in the spot market."[1] This means that traders are willing to pay more for gold that is available for delivery today, rather than lock in a futures contract at a discount for gold that is delivered months later.

Taking this one step further, if gold stays in backwardation for some time, it means that no one is taking advantage of a risk-free arbitrage opportunity by simultaneously selling physical gold at spot and buying a futures contract. In such a scenario, traders can keep not only the spread between the spot rate and the futures rate, but also their original position in gold. This is known as "de-carrying gold." Now, if enough traders were to take advantage of this risk-free profit, gold would be pushed out of backwardation into its normal trading state (i.e., "contango," when the price of a futures contract is higher than the physical spot price). The fact that this is not occurring, and that gold remains in backwardation, implies that gold is more and more decoupling from the dollar - a trend that, if continued, could raise the dollar price of gold and other assets significantly.[1]

Backwardation is quite common in other commodities like crude oil or copper, but in gold and even silver it should be exceedingly rare. Why? Because unlike the aforementioned commodities, the above-ground inventories of precious metals are mostly not consumed - they simply trade hands. Therefore, a sudden shortage of gold is not likely - it gains value by staying stable while currencies depreciate. Nonetheless, when gold does go into backwardation, it signals that there is not enough gold for sale to meet market demand. In other words, gold becomes "scarce."

This is precisely what is happening with gold now, and has been happening intermittently since 2008. Yet more recently, gold has been going further into backwardation (deeper spreads) and staying there longer (longer contract times).

GOFO Rate
The second important indicator of the demand for gold is a negative Gold Offered Forward, or "GOFO," rate.

"GOFO is calculated by subtracting the gold lease rate from the London Interbank Offered Rate [LIBOR], the average rate banks charge each other for loans. Note that normally, given the positive GOFO rate, people will employ gold to get their hands on dollars. In other words, gold is normally used as collateral to secure a dollar loan with interest."[2]

But what happens when the rate goes negative? A negative GOFO rate means that traders would rather give up dollars in order to secure gold bullion immediately and are willing to pay an interest rate to do so. Similar to gold backwardation, a negative GOFO rate signals that the demand for gold is overwhelming the available supply.

A Replay of 2008
So what's the big deal? Why are these somewhat obscure signs so important? There are at least two reasons you should pay attention.

First, there is history. The last time we saw gold in backwardation and a negative GOFO rate was in 2008, right before gold went into its largest and longest rally - setting record highs.

Keep in mind that the broader macro-economic factors that were instrumental in the financial crisis of 2008 (bailouts, aggressive bond-buying programs, and suppressed interest rates) have not dissipated at all, but rather increased. The Fed has maintained a relentless inflationary program since 2008 (QEI, II, III, and so on). This strongly indicates that what lies ahead for gold could potentially dwarf its post-2008 rally.

Second, the negative GOFO rate and backwardation of gold are important because they represent a clear measure of the demand for gold. They report to us without bias that the demand for gold is growing while the readily available supply is shrinking. What's more, they show a simultaneous decline in the demand to hold US dollars in favor of gold. This is perhaps the most striking takeaway from these indicators.

Ben Bernanke recently admitted that he doesn't understand gold. Peter Schiff likened this to a miner not understanding the role of the canary - an early warning indicator for dangerous gas leaks. Gold backwardation and a negative GOFO rate paint a picture as clear as a dead canary - investors are taking physical gold much more seriously.

1. Source: Keith Weiner, CEO of Monetary Metals, www.monetary-metals.com
2. Source: Peter Tenebrarum ,"Gold slips into Backwardation," www.acting-man.com/?p=24578

Dickson Buchanan is a Precious Metals Specialist at Euro Pacific Precious Metals. He received his MA in Austrian Economics from King Juan Carlos University in Madrid, Spain, and is currently enrolled in the doctorate program. Dickson joined the Euro Pacific Precious Metals team in 2012 after returning from his economic studies abroad.

This article first appeared in the August 2013 edition of Peter Schiff's Gold Letter, a monthly newsletter featuring original contributions from Peter Schiff, Casey Research, and other leading experts in the gold market. Click here for your free monthly subscription. To learn more about Peter Schiff's gold & silver dealer, visit www.europacmetals.com.

Peter Schiff Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules