Best of the Week
Most Popular
1. Gold vs Cash in a Financial Crisis - Richard_Mills
2.Current Stock Market Rally Similarities To 1999 - Chris_Vermeulen
3.America See You On The Dark Side Of The Moon - Part2 - James_Quinn
4.Stock Market Trend Forecast Outlook for 2020 - Nadeem_Walayat
5.Who Said Stock Market Traders and Investor are Emotional Right Now? - Chris_Vermeulen
6.Gold Upswing and Lessons from Gold Tops - P_Radomski_CFA
7.Economic Tribulation is Coming, and Here is Why - Michael_Pento
8.What to Expect in Our Next Recession/Depression? - Raymond_Matison
9.The Fed Celebrates While Americans Drown in Financial Despair - John_Mauldin
10.Hi-yo Silver Away! - Richard_Mills
Last 7 days
UK Coronavirus Infections and Deaths Trend Trajectory - Deviation Against Forecast - 1st Apr 20
Huge Unemployment Is Coming. Will It Push Gold Prices Up? - 1st Apr 20
Gold Powerful 2008 Lessons That Apply Today - 1st Apr 20
US Coronavirus Infections and Deaths Projections Trend Forecast - Video - 1st Apr 20
From Global Virus Acceleration to Global Debt Explosion - 1st Apr 20
UK Supermarkets Coronavirus Panic Buying Before Lock Down - Tesco Empty Shelves - 1st Apr 20
Gold From a Failed Breakout to a Failed Breakdown - 1st Apr 20
P FOR PANDEMIC - 1st Apr 20
The Past Stock Market Week Was More Important Than You May Understand - 31st Mar 20
Coronavirus - No, You Do Not Hear the Fat Lady Warming Up - 31st Mar 20
Life, Religions, Business, Globalization & Information Technology In The Post-Corona Pandemics Age - 31st Mar 20
Three Charts Every Stock Market Trader and Investor Must See - 31st Mar 20
Coronavirus Stocks Bear Market Trend Forecast - Video - 31st Mar 20
Coronavirus Dow Stocks Bear Market Into End April 2020 Trend Forecast - 31st Mar 20
Is it better to have a loan or credit card debt when applying for a mortgage? - 31st Mar 20
US and UK Coronavirus Trend Trajectories vs Bear Market and AI Stocks Sector - 30th Mar 20
Are Gold and Silver Mirroring 1999 to 2011 Again? - 30th Mar 20
Stock Market Next Cycle Low 7th April - 30th Mar 20
United States Coronavirus Infections and Deaths Trend Forecasts Into End April 2020 - 29th Mar 20
Some Positives in a Virus Wracked World - 29th Mar 20
Expert Tips to Save on Your Business’s Office Supply Purchases - 29th Mar 20
An Investment in Life - 29th Mar 20
Sheffield Coronavirus Pandemic Infections and Deaths Forecast - 29th Mar 20
UK Coronavirus Infections and Deaths Projections Trend Forecast - Video - 28th Mar 20
The Great Coronavirus Depression - Things Are Going to Change. Here’s What We Should Do - 28th Mar 20
One of the Biggest Stock Market Short Covering Rallies in History May Be Imminent - 28th Mar 20
The Fed, the Coronavirus and Investing - 28th Mar 20
Women’s Fashion Trends in the UK this 2020 - 28th Mar 20
The Last Minsky Financial Snowflake Has Fallen – What Now? - 28th Mar 20
UK Coronavirus Infections and Deaths Projections Trend Forecast Into End April 2020 - 28th Mar 20
DJIA Coronavirus Stock Market Technical Trend Analysis - 27th Mar 20
US and UK Case Fatality Rate Forecast for End April 2020 - 27th Mar 20
US Stock Market Upswing Meets Employment Data - 27th Mar 20
Will the Fed Going Nuclear Help the Economy and Gold? - 27th Mar 20
What you need to know about the impact of inflation - 27th Mar 20
CoronaVirus Herd Immunity, Flattening the Curve and Case Fatality Rate Analysis - 27th Mar 20
NHS Hospitals Before Coronavirus Tsunami Hits (Sheffield), STAY INDOORS FINAL WARNING! - 27th Mar 20
CoronaVirus Curve, Stock Market Crash, and Mortgage Massacre - 27th Mar 20
Finding an Expert Car Accident Lawyer - 27th Mar 20
We Are Facing a Depression, Not a Recession - 26th Mar 20
US Housing Real Estate Market Concern - 26th Mar 20
Covid-19 Pandemic Affecting Bitcoin - 26th Mar 20
Italy Coronavirus Case Fataility Rate and Infections Trend Analysis - 26th Mar 20
Why Is Online Gambling Becoming More Popular? - 26th Mar 20
Dark Pools of Capital Profiting from Coronavirus Stock Markets CRASH! - 26th Mar 20
CoronaVirus Herd Immunity and Flattening the Curve - 25th Mar 20
Coronavirus Lesson #1 for Investors: Beware Predictions of Stock Market Bottoms - 25th Mar 20
CoronaVirus Stock Market Trend Implications - 25th Mar 20
Pandemonium in Precious Metals Market as Fear Gives Way to Command Economy - 25th Mar 20
Pandemics and Gold - 25th Mar 20
UK Coronavirus Hotspots - Cities with Highest Risks of Getting Infected - 25th Mar 20
WARNING US Coronavirus Infections and Deaths Going Ballistic! - 24th Mar 20
Coronavirus Crisis - Weeks Where Decades Happen - 24th Mar 20
Industry Trends: Online Casinos & Online Slots Game Market Analysis - 24th Mar 20
Five Amazingly High-Tech Products Just on the Market that You Should Check Out - 24th Mar 20
UK Coronavirus WARNING - Infections Trend Trajectory Worse than Italy - 24th Mar 20
Rick Rule: 'A Different Phrase for Stocks Bear Market Is Sale' - 24th Mar 20
Stock Market Minor Cycle Bounce - 24th Mar 20
Gold’s century - While stocks dominated headlines, gold quietly performed - 24th Mar 20
Big Tech Is Now On The Offensive Against The Coronavirus - 24th Mar 20
Socialism at Its Finest after Fed’s Bazooka Fails - 24th Mar 20
Dark Pools of Capital Profiting from Coronavirus Stock and Financial Markets CRASH! - 23rd Mar 20
Will Trump’s Free Cash Help the Economy and Gold Market? - 23rd Mar 20
Coronavirus Clarifies Priorities - 23rd Mar 20
Could the Coronavirus Cause the Next ‘Arab Spring’? - 23rd Mar 20
Concerned About The US Real Estate Market? Us Too! - 23rd Mar 20
Gold Stocks Peak Bleak? - 22nd Mar 20
UK Supermarkets Coronavirus Panic Buying, Empty Tesco Shelves, Stock Piling, Hoarding Preppers - 22nd Mar 20
US Coronavirus Infections and Deaths Going Ballistic as Government Start to Ramp Up Testing - 21st Mar 20
Your Investment Portfolio for the Next Decade—Fix It with the “Anti-Stock” - 21st Mar 20
CORONA HOAX: This Is Almost Completely Contrived and Here’s Proof - 21st Mar 20
Gold-Silver Ratio Tops 100; Silver Headed For Sub-$10 - 21st Mar 20
Coronavirus - Don’t Ask, Don’t Test - 21st Mar 20
Napag and Napag Trading Best Petroleum & Crude Oil Company - 21st Mar 20
UK Coronavirus Infections Trend Trajectory Worse than Italy - Government PANICs! Sterling Crashes! - 20th Mar 20
UK Critical Care Nurse Cries at Empty SuperMarket Shelves, Coronavirus Panic Buying Stockpiling - 20th Mar 20
Coronavirus Is Not an Emergency. It’s a War - 20th Mar 20
Why You Should Invest in the $5 Gold Coin - 20th Mar 20
Four Key Stock Market Questions To This Coronavirus Crisis Everyone is Asking - 20th Mar 20
Gold to Silver Ratio’s Breakout – Like a Hot Knife Through Butter - 20th Mar 20
The Coronavirus Contraction - Only Cooperation Can Defeat Impending Global Crisis - 20th Mar 20
Is This What Peak Market Fear Looks Like? - 20th Mar 20
Alessandro De Dorides - Business Consultant - 20th Mar 20
Why a Second Depression is Possible but Not Likely - 20th Mar 20

Market Oracle FREE Newsletter

Coronavirus-bear-market-2020-analysis

More on Gold Backwardation

Commodities / Gold & Silver Dec 12, 2008 - 11:37 AM GMT

By: James_Turk

Commodities Best Financial Markets Analysis ArticleOver the last few weeks, there have been a lot of articles on the Internet about backwardation, i.e., when the price of commodities for delivery today is higher than the price of commodities for delivery in the future. Like nearly all the things on the Internet, most of what was written is useful, but some of it is total rubbish, and it takes time to sort through to find the gems from the rest. I offer the following in the hope that it clears up some of the confusion that has arisen about backwardation as well as to provide some insight into today's gold market.


Backwardations are no big deal in most commodities, but they are indeed a very big deal for gold.  Since I started following gold in the 1970s, I can recall seeing a gold backwardation against the US dollar only three times. Fortunately, we can pinpoint the exact dates from data made available by the London Bullion Market Association, which regularly posts the “GoFo” (gold forward) interest rate at its website.
http://www.lbma.org.uk/?area=stats&page=gofo/2008gofo
http://www.lbma.org.uk/stats/goldfwds

The first occurrence was November 29, 1995. That backwardation lasted for a day and was probably the result of a hedge buy-back by Barrick Gold completed then (one was announced by it shortly thereafter). 

The next occurrence lasted for two days, September 29-30, 1999, after several central banks announced the Washington Agreement on Gold. That accord set off a mad rush for physical gold to cover short positions in the wake of the price surge triggered by their announcement.

The third occurrence happened last month, and continued for three business days, November 20, 21 and 24. There was not any apparent event triggering this latest backwardation as there was with the two previous occurrences. But it probably reflects the exceptionally strong demand recently for physical metal.

We can reasonably conclude from the above observations that gold rarely trades in backwardation. It almost always trades in contango, i.e., the price for delivery today is lower than the price for delivery in the future . Therefore, gold is very different from other commodities, all of which frequently trade in backwardation.  Why is gold different?

Gold is money. In other words, gold's usefulness does not arise from its consumption, but rather, from its accumulation. In contrast to all other commodities, gold does not get used up and consumed in its applications. Rather, gold is hoarded, or as I like to say it because it is money, gold is saved.

Gold therefore contrasts to all other commodities because it has a huge aboveground stock of inventory that is available to come back into the market in exchange for national currencies if the price is right. This aboveground stock is comprised of essentially all the gold mined throughout history. Other commodities have very little aboveground stock relative to the amount consumed, with the result that shortages in these other commodities can and do occur.

These shortages make it difficult if not impossible to arbitrage any backwardation that appears in these other commodities. If there were a huge aboveground inventory, one could sell their inventory today and buy it back in the future at a cheaper price, profiting from the difference.

Gold's huge aboveground stock makes it different from other commodities. Backwardation in gold does not occur in practice because there are always people willing to profit by selling some of their hoard in the spot market and buying back gold at a lower price in the future, except the three rare instances noted above.

In the first two instances, the market for physical gold was temporarily disrupted. The reasons for the third backwardation are not yet certain, but it is important to consider its possible causes.

The demand for physical gold has been strong recently for a number of reasons, but perhaps the two most important are relatively low US dollar interest rates and the growing concern about counterparty risk. These factors make holding physical gold an increasingly attractive alternative compared to holding US dollars in particular and national currencies generally, and as a result, it is possible that November's backwardation may be the precursor of a fundamental change in the gold market. What could that change be? We don't need to speculate here because there are only two possible answers.

The first is that gold goes into backwardation because no one who owns gold is willing to sell their hoard at the current price. I noted this possibility in my August 17 th alert <> http://www.goldmoney.com/en/commentary/2008-08-17.html <> posted on the GoldMoney website. I wrote back then:

“The extraordinary demand for coins and small bars can be viewed as an early sign that the market is moving into backwardation. In other words, the backwardation is in effect being reflected by higher premiums above spot for physical metal, rather than spot itself rising and going into backwardation. 

Central banks do not transact in small bars and their coin transactions are inconsequential compared to the size of the market. So the market for fabricated product is relatively free from government influence. But central banks of course exert a dominant influence on the market for LBMA-sized bars by using their existing gold stocks, and they can keep the spot price for gold (which is determined by the buying/selling of LBMA-sized bars) artificially low by dishoarding gold from their vaults.

So my thought is that if gold does not climb back above at least $900 quickly, a shortage of LBMA-sized bars will develop unless central banks allow their vaults to be cleaned out, much like Ft. Knox was drained in the weeks leading up to the 2-tiered London gold price created in March 1968.”

The 3-day backwardation in November indicates that a shortage of LBMA bars seems to be developing. The implication is that the gold cartel is about to lose its grip on the gold market, and can no longer cap the gold price at current levels.

The second possible answer is more ominous. If gold does trade in backwardation against US dollar for a protracted period (again, barring a very short-term and ephemeral event like the first two instances noted above in which a temporary demand for physical gold disrupts normal market activity), it will mean that a collapse of the dollar has begun. Think about it.  How could gold go into backwardation for any prolonged period?  If it does, it would mean that no one is willing to take the risk of selling their hoard and instead hold US dollars. It would mean that no one is willing to accept the risks that come with holding dollars while waiting until they can be used at a future date to exchange back into gold.

Those risks are:

•  the dollar can be created out of thin air by governments, and

•  holding dollars has counterparty risk. 

The trillions of dollars of newly created bail-out money highlight the first risk, and the sad state of the banking industry today makes clear the second.

Physical gold has neither of these risks.  So because of the greater risk of holding dollars, dollar interest rates are higher than gold's interest rates. In short, the higher interest rate currency is always in backwardation when the forwards are measured against a currency with lower interest rates.

In recent years, the politically correct thing to do is to call gold's interest rate a “lease rate”, which is unfortunate.  If people recognized that gold has an interest rate because it is money, they would more quickly grasp the significance of a gold backwardation if it were to occur. The contango is gold's interest rate. 

For more information about gold backwardation, I recommend the following:

1) a monograph entitled “Golden Sextant” by Reg Howe, which is available at the following link: http://www.goldensextant.com/goldensextant.html

2) an article by Doug Pollitt, of Pollitt & Co. in Toronto , which can be downloaded by clicking here .

In summary, the market for physical gold is tight. The extraordinarily high premiums now being charged on coins and small bars is the most visible aspect of this incredible tightness. The negative GoFo rate for three days in November is another example.

This tightness in the physical market for gold could be a passing phenomenon, but then again, maybe not. It may be any indication that the gold market is profoundly changing, which will cause the price of gold to soar because the gold cartel is unable or unwilling to use any of its remaining inventory to cap the gold price at current levels, or because US dollar is becoming suspect. Then again, it is not unreasonable to conclude that both factors may be at work here. After all, the collapse in the US Dollar Index this month strongly suggests that the dollar's 4-month bear market rally ended in November.

In any case, we'll know for sure that the gold price is ready to soar if GoFo goes negative and remains negative. If that happens, take note of the old saying that a bird in the hand is worth two in the bush. Own physical metal and not paper.

By James Turk
http://goldmoney.com

James Turk is the Founder & Chairman of GoldMoney.com < http://goldmoney.com>. He is the co-author of The Coming Collapse of the Dollar, which has been updated for a newly released paperback version, now entitled The Collapse of the Dollar < www.dollarcollapse.com >.

Copyright © 2008 by James Turk. All rights reserved.

Disclaimer: The above is a matter of opinion and is not intended as investment advice. Information and analysis above are derived from sources and utilizing methods believed reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Do your own due diligence.

James Turk Archive

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


Comments

Doug Griffith
16 Dec 08, 10:28
More on Gold Backwardation

Jim, from the link you provided at goldensextant:

"In dollar denominated forward and futures markets for gold, arbitrage results in a contango that is ordinarily slightly below the U. S. treasury bill rate. In the currency markets, arbitrage puts currencies with lower interest rates in contango against those with higher rates, and currencies with higher rates in backwardation against those with lower rates. All currencies are in backwardation against gold since it carries a lower interest rate structure than any currency."

Wouldn't this be the easiest explanation for the current backwardation - recent low, and even negative t-bill rates have temporarily compressed the natural arbitrage of gold libor, causing it to have a slight backwardation? It seems more plausible, and less dramatic then the other musings on the subject...


Post Comment

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

6 Critical Money Making Rules