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Since late January, the February gold contract has been in backwardation. This means that one could make a profit by simultaneously selling a gold bar and buying a February contract. One would still have one’s gold plus a little extra. I coined the term “temporary backwardation”, to describe this curious and very recent phenomenon. In our “new normal”, most gold and silver contracts go into backwardation as they get close to expiry.
When the Feb contract first jumped into backwardation, it was well within the “contract roll” period. The roll is when naked longs sell the expiring contract and buy a contract for a more distant month. This heavy selling of the expiring contract pushes down its price. Since cobasis is Spot minus Future (oversimplified slightly), the cobasis rises purely due to the mechanics of this selling.
But today something more serious occurred. The April contract, which is not yet being “rolled”, fell into backwardation. See the chart.
The market is offering a free profit to anyone who will sell a gold bar and buy an April contract. For whatever reason, no one is either able or willing to take the bait. This is proof that the market for physical gold metal is drying up. Speculators in the futures markets may believe that the gold price “should” fall because the central banks say they are not going to competitively devalue their irredeemable paper currencies. Owners of real metal are increasingly reluctant to part with it at the current price.
We don’t recommend that anyone ever naked short the monetary metals. Instead, we always advise to use an arbitrage position such as long gold / short silver.
Using the basis theory, we have been bearish on silver this year, against the consensus posting two videos (here and here).
Using the basis theory on gold today, we would suggest that now is a great time and a great price to buy gold.
And to those who may be shorting gold due to downward momentum, we would say this. Caveat venditor.
http://www.zerohedge.com/contributed...-backwardation
This a peculiar enough phenomenon by itself. However, when I read it, I was reminded of something even stranger. Antal Fekete, a deflationist (sic!) "new austrian schooler", has written about gold backwardation before, referring to it as a major turning point in the gold endgame story:
the elimination of research on the monetary role of gold is striking back. These ‘competent’ and ‘honorable’ gentlemen at the helm are perfect ignoramuses when it
comes to gold basis, that is, the difference between the nearest future and the spot price of
gold. They have no notion of the continuous and inexorable erosion of the gold basis for the past 40 years from its top reading in 1972 all the way to zero now. Worse still is the fact that
they don’t understand the significance of the irresistible march of the gold futures markets
into the death valley of permanent backwardation.
When the basis goes irreversibly negative and permanent backwardation sets in, gold
is not available at any price. At that point the U.S. Treasury bonds cease to be redeemable in
gold at any rate of exchange. This may not bother the Keynesian and Friedmanite botchers
at the Fed and the Treasury unduly, but it will certainly upset all those who accept them as
collateral for the currency, among others, all the producers of real goods and services. Their
refusal to accept irredeemable promises in payment for real goods and real services will
trigger an irresistible slide into barter as far as essential commodities are concerned. The
world is insidiously slipping back into direct exchange for want of money acceptable in
indirect exchange. However, you cannot feed the world’s present population on the basis of
a barter economy. Poverty, pestilence, famine threatens society, not to mention the
breakdown of law and order. All this, and more, because government leaders have
suppressed not only monetary gold itself, but also any meaningful research on its role in the
global economy.
Permanent gold backwardation, if nothing else will, must finally bring about a
sovereign debt crisis in America as it metastasizes across the Atlantic. It will herald the
arrival of the moment of truth. It will reveal without the shadow of a doubt that the U.S.
Treasury bond is irredeemable; that it promises to pay nothing but more of itself; that the
Fed backing Federal Reserve notes with Treasury paper while the Treasury paper is payable
in Federal Reserve notes is just a legalized check-kiting scheme. The dollar would have gone
the way of the Assignat and the Reichsmark a long time ago but for the fact that it could still
be exchanged for gold (however little). To most people this fact suggests that the dollar will
always command some gold (albeit a variable amount). These people are ignorant of the
vanishing of the gold basis that is about to turn negative for the first time in all history.
comes to gold basis, that is, the difference between the nearest future and the spot price of
gold. They have no notion of the continuous and inexorable erosion of the gold basis for the past 40 years from its top reading in 1972 all the way to zero now. Worse still is the fact that
they don’t understand the significance of the irresistible march of the gold futures markets
into the death valley of permanent backwardation.
When the basis goes irreversibly negative and permanent backwardation sets in, gold
is not available at any price. At that point the U.S. Treasury bonds cease to be redeemable in
gold at any rate of exchange. This may not bother the Keynesian and Friedmanite botchers
at the Fed and the Treasury unduly, but it will certainly upset all those who accept them as
collateral for the currency, among others, all the producers of real goods and services. Their
refusal to accept irredeemable promises in payment for real goods and real services will
trigger an irresistible slide into barter as far as essential commodities are concerned. The
world is insidiously slipping back into direct exchange for want of money acceptable in
indirect exchange. However, you cannot feed the world’s present population on the basis of
a barter economy. Poverty, pestilence, famine threatens society, not to mention the
breakdown of law and order. All this, and more, because government leaders have
suppressed not only monetary gold itself, but also any meaningful research on its role in the
global economy.
Permanent gold backwardation, if nothing else will, must finally bring about a
sovereign debt crisis in America as it metastasizes across the Atlantic. It will herald the
arrival of the moment of truth. It will reveal without the shadow of a doubt that the U.S.
Treasury bond is irredeemable; that it promises to pay nothing but more of itself; that the
Fed backing Federal Reserve notes with Treasury paper while the Treasury paper is payable
in Federal Reserve notes is just a legalized check-kiting scheme. The dollar would have gone
the way of the Assignat and the Reichsmark a long time ago but for the fact that it could still
be exchanged for gold (however little). To most people this fact suggests that the dollar will
always command some gold (albeit a variable amount). These people are ignorant of the
vanishing of the gold basis that is about to turn negative for the first time in all history.
One reason, perhaps the chief reason for |the German gold repatriation| is that the managers of the global fiat money system are preparing for the coming showdown, the final curtain
on what some years ago I dubbed The Last Contango in Washington. In other
words, policymakers are preparing for (or trying to fend off) permanent
backwardation in the world’s gold futures markets that is threatening to rip apart
the present shabby make-belief payments system of the world.
Contango is the normal condition of the gold futures markets when the spot
price of gold is at a discount relative to the price of futures contracts. It
demonstrates that plenty of gold is available to satisfy present demand. People are
confident that promises to deliver gold will be honored. The condition opposite to
contango is called backwardation that obtains when the futures price loses its
premium relative to the spot price and goes to a discount. In the gold market this
condition is highly anomalous because, on the face of it, it allows traders to earn
risk free profits. They sell spot gold at a premium, and buy it back at a discount for
future delivery. However, risk free profits are ephemeral since the very action of
traders will instantaneously eliminate them. What this suggests is that permanent
backwardation in gold could never happen by the very nature of the case.
Yet unknown to the general public a very great danger is looming, the like of
which has not threatened the world since the collapse of the Western half of the
Roman Empire more than fifteen hundred years ago. This danger, should it
materialize, would mark the end of our civilization and the beginning of a new
Dark Age. I am talking about a threat of the sudden and complete collapse of world
trade. It would be heralded by permanent gold backwardation, something that
allegedly could never happen. Hard on its heels would follow the collapse of the
dollar payments system. Barter, of course, would take place between neighboring
countries, but world trade as we know it would disappear altogether.
on what some years ago I dubbed The Last Contango in Washington. In other
words, policymakers are preparing for (or trying to fend off) permanent
backwardation in the world’s gold futures markets that is threatening to rip apart
the present shabby make-belief payments system of the world.
Contango is the normal condition of the gold futures markets when the spot
price of gold is at a discount relative to the price of futures contracts. It
demonstrates that plenty of gold is available to satisfy present demand. People are
confident that promises to deliver gold will be honored. The condition opposite to
contango is called backwardation that obtains when the futures price loses its
premium relative to the spot price and goes to a discount. In the gold market this
condition is highly anomalous because, on the face of it, it allows traders to earn
risk free profits. They sell spot gold at a premium, and buy it back at a discount for
future delivery. However, risk free profits are ephemeral since the very action of
traders will instantaneously eliminate them. What this suggests is that permanent
backwardation in gold could never happen by the very nature of the case.
Yet unknown to the general public a very great danger is looming, the like of
which has not threatened the world since the collapse of the Western half of the
Roman Empire more than fifteen hundred years ago. This danger, should it
materialize, would mark the end of our civilization and the beginning of a new
Dark Age. I am talking about a threat of the sudden and complete collapse of world
trade. It would be heralded by permanent gold backwardation, something that
allegedly could never happen. Hard on its heels would follow the collapse of the
dollar payments system. Barter, of course, would take place between neighboring
countries, but world trade as we know it would disappear altogether.
Of course, false alarms can and do occur, and it is possible that gold goes into backwardation and then promptly comes out of it. It has happened before. But
here we are looking at a 35-year trend, embracing the entire history of gold
futures trading. The trend has been that, as a percentage of the prevailing rate of
interest the basis has been falling from practically 100% to practically 0%.
You and I know the reason for this: it has to do with the vanishing of all
newly mined gold into private hoards at an accelerating pace; the insatiable
appetite in the world to snap up all available gold by well-heeled governments
and individuals who no longer believe in the tooth fairy residing in the Federal
Reserve.
You have to remember that the basis is widely used as a guide in the huge
arbitrage operations between gold holdings and dollar balances and in the gold
carry trade. To participate in this arbitrage you must have gold on deposit in
Comex warehouses. But with the vanishing of the gold basis the profitability of
this arbitrage as well as that of the gold carry trade has been drying up, which
explains the dwindling of warehouse stocks.
Another consequence of the vanishing of the gold basis is that it makes
the risks involved in the gold/paper arbitrage rather lopsided, as far greater risks
are assigned to short positions on gold and long positions on the dollar, than on
long positions on gold and short positions on the dollar. The arbitrageurs are
very much alive to this lack of symmetry, and are increasingly unwilling to put
their gold in harm’s way. They are fully aware that we are approaching an
historic milestone, one that has never been passed before: the milestone marking
the last contango. As a consequence of this lopsidedness the gold futures
markets can no longer coax gold out of hiding. In vain do futures markets
promise risk-free profits for taking over the carry from the individual.
Here is the deal they offer you: give us your cash gold in exchange for
gold futures that we’ll let you have at a deep discount, so that you can pocket
risk-free profits. The offer is increasingly declined. There was a time when a
drop in the basis would pull in gold from the moon, figuratively speaking. No
more. Arbitrageurs no longer believe that gold futures are fully exchangeable
for cash gold.
Gold backwardation is virtually inevitable and when it comes, it will be
irreversible. Why? Because it signifies a crisis of the first magnitude: the general
disappearance of gold from trade for reasons of lack of confidence. No one will
give up gold, because one is no longer confident that he can get it back on the
same terms. Vanishing confidence is like a runaway train. The only thing that
might turn this runaway train around is a steep rise in US interest rates.
However, this is not in the cards. It would ruin what is left of the US economy.
here we are looking at a 35-year trend, embracing the entire history of gold
futures trading. The trend has been that, as a percentage of the prevailing rate of
interest the basis has been falling from practically 100% to practically 0%.
You and I know the reason for this: it has to do with the vanishing of all
newly mined gold into private hoards at an accelerating pace; the insatiable
appetite in the world to snap up all available gold by well-heeled governments
and individuals who no longer believe in the tooth fairy residing in the Federal
Reserve.
You have to remember that the basis is widely used as a guide in the huge
arbitrage operations between gold holdings and dollar balances and in the gold
carry trade. To participate in this arbitrage you must have gold on deposit in
Comex warehouses. But with the vanishing of the gold basis the profitability of
this arbitrage as well as that of the gold carry trade has been drying up, which
explains the dwindling of warehouse stocks.
Another consequence of the vanishing of the gold basis is that it makes
the risks involved in the gold/paper arbitrage rather lopsided, as far greater risks
are assigned to short positions on gold and long positions on the dollar, than on
long positions on gold and short positions on the dollar. The arbitrageurs are
very much alive to this lack of symmetry, and are increasingly unwilling to put
their gold in harm’s way. They are fully aware that we are approaching an
historic milestone, one that has never been passed before: the milestone marking
the last contango. As a consequence of this lopsidedness the gold futures
markets can no longer coax gold out of hiding. In vain do futures markets
promise risk-free profits for taking over the carry from the individual.
Here is the deal they offer you: give us your cash gold in exchange for
gold futures that we’ll let you have at a deep discount, so that you can pocket
risk-free profits. The offer is increasingly declined. There was a time when a
drop in the basis would pull in gold from the moon, figuratively speaking. No
more. Arbitrageurs no longer believe that gold futures are fully exchangeable
for cash gold.
Gold backwardation is virtually inevitable and when it comes, it will be
irreversible. Why? Because it signifies a crisis of the first magnitude: the general
disappearance of gold from trade for reasons of lack of confidence. No one will
give up gold, because one is no longer confident that he can get it back on the
same terms. Vanishing confidence is like a runaway train. The only thing that
might turn this runaway train around is a steep rise in US interest rates.
However, this is not in the cards. It would ruin what is left of the US economy.
we have to explain the relevance of this to the present credit crisis.
It is no secret that the bonds, notes, bills, and other obligations of the United
States government, or any other government for that matter, are irredeemable.
That is, they are redeemable in nothing but more of the same. For example, the
bonds of the U.S. Treasury are redeemable in Federal Reserve credit, which is
itself irredeemable and is ‘backed by’ the self-same bonds of the U.S. Treasury.
Why is it, then, that these Treasury obligations are in demand, where one might
think that redeemability is a sine-qua-non of issuing them? What makes people
participate in this shell-game? How can such a crude check-kiting scheme
mesmerize the entire population of our globe? Come to think of it, the sight of
this Ponzi scheme would shudder the Founding Fathers of our great Republic.
This is not an easy question to answer. But going through all the
alternative explanations one-by-one, we come to the conclusion that the debt of
the U.S. government is still redeemable in a sense, however limited or restrictive
it may be. The debt of the U.S. government has a liquid market in which it can
be exchanged for Federal Reserve credit. In turn, Federal Reserve credit can still
be exchanged in liquid markets for physical gold, the ultimate extinguisher of
debt, albeit at a variable price. But if you break that final link, when gold is no
longer for sale at any price quoted in U.S. dollars, then the rug will have been
pulled from underneath this house of cards, and the international monetary
system will collapse like the twin towers of the World Trade Center. And this is
the situation that we are now confronted with.
Look at it this way. There is a casino where the lucky gamblers can
gamble risk-free. Their bets are ‘on the house’. This casino is the U.S. bond
market. There is only one catch. The pile of the winning chips in front of each
gambler may become irredeemable at the exit when the hairy godfather waves
his magic wand. As the gold markets enter their phase of permanent backwardation, all
rational basis for holding U.S. Treasury debt, or any debt for that matter, will
disappear. There will be a mad rush to the exits, and holders of debt will trample
one another to death in trying to cash in on their winnings.
It is no secret that the bonds, notes, bills, and other obligations of the United
States government, or any other government for that matter, are irredeemable.
That is, they are redeemable in nothing but more of the same. For example, the
bonds of the U.S. Treasury are redeemable in Federal Reserve credit, which is
itself irredeemable and is ‘backed by’ the self-same bonds of the U.S. Treasury.
Why is it, then, that these Treasury obligations are in demand, where one might
think that redeemability is a sine-qua-non of issuing them? What makes people
participate in this shell-game? How can such a crude check-kiting scheme
mesmerize the entire population of our globe? Come to think of it, the sight of
this Ponzi scheme would shudder the Founding Fathers of our great Republic.
This is not an easy question to answer. But going through all the
alternative explanations one-by-one, we come to the conclusion that the debt of
the U.S. government is still redeemable in a sense, however limited or restrictive
it may be. The debt of the U.S. government has a liquid market in which it can
be exchanged for Federal Reserve credit. In turn, Federal Reserve credit can still
be exchanged in liquid markets for physical gold, the ultimate extinguisher of
debt, albeit at a variable price. But if you break that final link, when gold is no
longer for sale at any price quoted in U.S. dollars, then the rug will have been
pulled from underneath this house of cards, and the international monetary
system will collapse like the twin towers of the World Trade Center. And this is
the situation that we are now confronted with.
Look at it this way. There is a casino where the lucky gamblers can
gamble risk-free. Their bets are ‘on the house’. This casino is the U.S. bond
market. There is only one catch. The pile of the winning chips in front of each
gambler may become irredeemable at the exit when the hairy godfather waves
his magic wand. As the gold markets enter their phase of permanent backwardation, all
rational basis for holding U.S. Treasury debt, or any debt for that matter, will
disappear. There will be a mad rush to the exits, and holders of debt will trample
one another to death in trying to cash in on their winnings.
There's a few more articles on it here: http://www.professorfekete.com/articles.asp
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