Silver in Backwardation; Has the Last Cantango Been Danced in Washington?

[In case you do not yet understand futures markets, "backwardation" means that silver to be delivered today is now being priced higher than metal to be delivered later in the London Bullion Market Association's futures market in London, England. For more details on backwardation, please refer to my five-part December series which starts here "The End for the Dollar and all Fiat Currencies (1/5)". Contango is the opposite of backwardation and exists when futures price is higher than the spot price as I explained for those new to futures terminology here "The Money Matrix - What the Heck Are Derivatives? (PART 10/15)". As you read, please also note that I am NOT a commodities trader, I am just an engineer by trade, so feel free to help me out with my analysis or mistakes. ( Photo) (2)

As we learned in "The Significance of Gold Backwardation Explained (4/5)", backwardation is a sign of a very tight market, and a market that will be tight for sometime into the future either because: 1) current supply is very tight, 2) future supply is projected to be very tight, or 3) there is a severe distrust in counterparties that the short positions can deliver the goods on time per the contract, or vice versa that the long positions will not have the cash.]

While gold traded as a "store of value" (a currency, really), very little is actually consumed. Silver, on the other hand, serves as both an industrial metal and a "store of value" for silver investors. As we learned here, both silver and gold are precious metals since there is very little above ground stock. All of the gold stock in the world would fit into a cube 20.5 meters to a side. Due to high amounts of industrial usage, the silver stock is even smaller, less than 14.5 meters to a side.

Please refer to the below graphs (click to enlarge) of LBMA's silver mid rate, which is the midway point between the bid and offer prices. Here is what I note:

• Silver for all traded futures contracts (whether 1 month or 12 months) have been in backwardation for seven trading days since January 21.
• This backwardation is about three times more severe than the mild backwardation than existed from December 8 through December 24 in 2008.
• We can see that since 2006-2007 where rates were about 4-5%, this state of backwardation is fairly unusual. (The LBMA only lists data back to 2006, but I believe it is a fair comment to say that on an even longer timeline, this is unusual.)
• Furthermore, starting in roughly June 2008, the 12-month SIFO rate flipped over from being the lowest rate to, in general, the highest.
• Also, the disparity between the rates seen in 2006-2007 has largely disappeared; the market appears to be treating a trade on silver 12 months later as quite similar to a trade on silver 1 month later.

[All graphs in this article were created by author from this LBMA source.]

Let's now also look at the LBMA Silver Fix price history for a 1000 troy ounce bar. While at the end of the graph, the loss of purchasing power relative to the euro and dollar by the British pound can easily be seen, I remark that despite all of the tightness in the market as demonstrated by the SIFO chart, the price of silver is still well below the average price for 2006-2008.

It is simply too early to tell if we have seen the "Last Contango," but as Dr. Fekete notes in "The Last Contango in Washington" (2006) and "Keeping Our Eyes Peeled for the Silver and Gold Basis" (2007), the consequences could be very stark for the dollar and hence all fiat currencies.

Now, of course, there are many other factors as silver guru Theodore Butler points out in "Tightening Production". Industrial demand has been slammed by the economic fallout. However, since about 70% of all silver is typically mined as a by-product with other base metals like zinc, the supply is also greatly affected by the market conditions of zinc, copper, lead, and nickel. While the backlog in demand has greatly increased the inventories of these base metals causing a drop in their prices, the inventory of silver is growing smaller while the price has increased over the past three months from $10 to $12/oz.

Butler also relates that many of the base metal mines have been closing since they are no longer profitable. At the same time, Butler reports that the American COMEX silver futures market is under investigation by the CFTC (Commodities and Futures Trading Commission) for market manipulation and price suppression. However, since the market is located in London, I suppose this backwardation could also be temporary due to the severe loss of purchasing power (relative to others) of the British pound.

[For the Reader, NYMEX Gold Session Futures chart, Silver Session Futures chart. Gold spot price chart. Silver spot price chart. When the spot price is greater than the futures price, backwardation exists.]

Let's now take a quicker look at gold traded at LBMA. The GOFO, or Gold Forward Offered Rate, represents the rates at which dealers will lend gold on a swap basis against US dollars. From the below charts, I note:

• Recently, gold has only gone into minor backwardation once, in November 2008, for 3 days.
• As GOFO started its plummet in roughly September 2007, the prices began to diverge, and currently the 1-month GOFO rate is lower than the 12-month rate.
• Again, the buckling of the British pound can be easily seen.
• The British pound set an all-time high of 656 pounds per ounce of gold this week on January 26, 2009.
• The euro set an all-time high of just under 700 euros per ounce of gold this week on January 26, 2009.
• Gold priced in dollars is still 14% below its 2008 high of $1,023, as of January 29.

The reader should be aware I highlighted in my last article "GATA's Message on Gold and Silver Manipulation to Barack Obama (PART 2/2)" and support the group known as GATA in their battle to bring about an end to the suppression that I perceive exists from the evidence GATA has gathered. As the GOFO rate is just barely positive (+0.2%) as I write, I warn you of what will happen if gold lapses into permanent backwardation. Or rather, I will let James Turk of goldmoney.com warn you:

If gold does trade in backwardation against the US dollar for a protracted period..., 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.

Got silver? Got gold? To those I believe who are suppressing the free market of these two monetary metals, my message is from this Offspring video full of gold and silver coins:

So dance, ******, dance!
...Hit ‘em right between the eyes!
Hit ‘em right between the eyes!
When you walk away,
Nothing more to say!
See the lightning in your eyes!
See ‘em running for their lives!

Everyone else, get some while it is still cheap!

Comments

[Conan the B...:]

I guess I just can't seem to get it into my head how one thing means something else for a different commodity.

Oil is in Contango and bullish because the belief is that current prices are too low and will be higher in the Future. Here there is No current demand but demand is expected to pick up.

Yet Gold/Silver Backwardization is considered Bullish Also even though Future's prices are lower. Here you have current demand but the future's price indicates that demand is expected to slow.

Could you please explain what the difference is?

As the premium on physical Gold and Silver declines, will that be a sign of a reversal in both Commodities?

Feb 02 05:17 AM

[ROLEX18K:]

Now regarding backwardation, not only in Gold or Silver but in other commodities as well.
Silver futures have about 1 year of backwardation, Gold only 3 months.
What it means in this case? It means that deflation that is witnessed in global economy finally starts to work reaching almost any asset, the Nickel, Copper or Steel crashed at some point 80% in few months while Gold didn't and explanation is that investors look at Gold as some magic metal, in fact it is not and backwardation while very insignificant already states the mind of producers who sell Gold today for later delivery, they know that they have expenses in USD$ not Gold ounces, for them Gold is a commodity same as potato to a farmer, they digg it to sell it, not to collect.
Silver will crash more than Gold, that's why almost 12 months of backwardation, the main Silver use silverware is almost non existing anymore and out of fashion, the industrial use is declining together with declining industries that use it and the best barometer of world industries is DJIA, DAX, FTSE, NIKKEI indexes which are all down.
From my past observations, backwardation in any commodity is a bearish indicator for up to 5-7 years.Stay tuned.

Feb 02 07:34 AM

[thesnowjob:]

Rolex backwardation is anything but bearish.

Crude went into backwardation in 2004 after being in contango for many years.

Feb 02 09:55 AM

[Conan the B...:]

Gold was in contango throughout the 70's which pointed to higher inflation. But Now That its in Backwardation how does it still point to higher inflation?

What other historical data is available on either gold or silver which led to higher prices for either in the following 6, 12, 18 month periods.

I see a lot of material on Backwardation but I have yet to see any historical comparison.

Meanwhile the Author says: "Contango is the opposite of backwardation..."

Does this mean that Oil prices are going to fall in the future because they are in Contango?

Like I said, I do not see how Contango in oil and Backwardation in Gold/silver can be the "opposite" of each other but lead to higher prices in both.

Backwardation is an unproven theory until Historical Backup is provided. IMHO

Feb 02 11:02 AM

[scotty1560:]

how long can backwardation typically last?

Feb 02 11:28 AM

[doubleguns:]

Gold and silver are two "commodities" that can also be saved as a form of wealth preservation. No one hoards corn, soy, or pork bellies for years to come. They would rot. That is the difference in these commodities. Oil going up would indicate inflation coming but with supplies being manipulated no one can say with certainty what actually caused the price to start going up-shortage?. Silver and gold price in backwardation might indicate inflation or possibly just fear. Fear that inflation is coming soon but not here yet or fear of the fiat failing soon. People want it now not later and will pay more for it NOW than they will in the future. They want the insurance policy now. Thus we have speculation. If they are right in thier bet the future price will surge and you wont get it with out pain and suffering in the wallet because you are too late. That is the reason it is so expensive now not later. Place your bets folks and play the cards you requested. Having some gold and silver NOW to hedge your bets might just be good insurance.

Feb 02 12:04 PM

[Conan the B...:]

So, Backwardation can be summed up with "Fear" of the Now. And Gold/Silver help people cope with that fear.

I'll have to look at what might consitute such an index.

Maybe the GSR against the VIX?

Feb 02 04:07 PM

[Jake Towne:]

Thank you all for your comments!

Dear Scotty1560 -
I can say with perfect clarity that I have no idea whatsoever how long this will last. If I thought I knew the CAUSE of the backwardation (and I don't), I would have a shot at predicting something. At the start of the article I suggested 3 reasons why backwardation exists in any commodity.

Dear paultaut -
Here are my attempts at your questions.

"Could you please explain what the difference is?"
Gold is very different from any other commodity I am aware of. This is because its aboveground stock is MANY, MANY times its annual production. Silver, oil, wheat, copper, etc. usually have somewhere around a year of unconsumed stock in aboveground stock.

My opinion is backwardation in gold can be quite serious as Turk notes above.

FYI, I didnt understand futures markets very well until a couple of months ago. I recommend trying these articles and links inside, that I put together if you want
www.nolanchart.com/art...
www.nolanchart.com/art...

"As the premium on physical Gold and Silver declines, will that be a sign of a reversal in both Commodities? "
The fairest answer I can give here is maybe, but I also have reason (try my other recent articles at my website) to believe the market is manipulated ala gata.org. Sorry :)

Feb 02 07:02 PM

[GMiki1:]

Oil is said to be in supercontango, not just contango, indicating a prcie rise expected of at least 50 percent. Whether that points to inflation or simply shortages due to cuts in production, I don't know. An ordinary amount of contango is expected in commodities for storage costs, etc.

Backwardation in gold and silver is said to be bullish and I believeAntal Fekete is someone who has written about this as well.

Feb 02 07:53 PM

[Conan the B...:]

Gmiki: The link Jake provides is the same as yours, a
paper by Antele Fekete.

To my knowledge, there is no historical data support nor have any Articles been written regarding this phenomena in past decades.

You cannot overlay a chart comparing this New activity with Gold's activity from any decade in the past because there is nothing from the past to overlay.

Please don't try to include the Soft commodities with the Hard.

Jake: your own words.

"Gold is very different from any other commodity I am aware of. This is because its above ground stock is MANY, MANY times its annual production. Silver, oil, wheat, copper, etc. usually have somewhere around a year of unconsumed stock in above ground stock."

Think about the above. If there were indeed Usually about a year's worth of silver, oil etc. in inventory, commodity prices would not have continuously risen. High Inventory Does Not increase the price, Demand and Low expectations of the filling of that demand increases the price both present and future.

Gold is Unique. It has its place in history not only as a currency but also as a historical archive, an inflation hedge, and in some past cultures for its decorative look.

Gold Leaf, plate, flakes, coins, ingots, etc., if you are going to buy gold as an inflation hedge for perceived future inflation, then the absense of Contango should be a worry.

A Worry, not a Death Knell.

When I fully realized the extent of the Government's manipulation of physical gold in times past, I also realized they had finally figured out how to Game the markets. They have "forced" the shorts to cover many times over the last 6 months, Futures Manipulation of Gold would not surprise me either.

Feb 03 02:06 AM

[Conan the B...:]

Jake: One other thing your theory leaves out.

If gold futures move back into Contango, This would be a Sell signal under the reasoning put forth.

I would be a rip roaring bull, because we would have moved from deflationary to inflationary expectations.

IMHO

Feb 03 10:45 AM

[Jake Towne:]

Dear paultaut -
Interesting points! Thanks!


On Feb 03 10:45 AM paultaut wrote:

> Jake: One other thing your theory leaves out.
>
> If gold futures move back into Contango, This would be a Sell signal
> under the reasoning put forth.
>
> I would be a rip roaring bull, because we would have moved from deflationary
> to inflationary expectations.
>
> IMHO

Feb 03 06:54 PM

[Bron Suchecki:]

Suggest you subscribe to www.sharelynx.net/, he should have SIFO data back to 1999. Silver was in severe backwardation in Dec01 to Mar 02 and a few times during the second half of 2003.

Feb 04 11:07 PM

[Stephen Str...:]

Gold backwardation means that anyone with physical gold could sell it now, get interest on the cash AND buy it back cheaper l later, having also saved on storage costs - a win win win situation.

So how could backwardation in gold arise?

(1) Interest rates and storage costs would have to be minimal
(2) Holders fear counterparty risk - a deflationary phenomenon, but also a sign of a bull market where counterparties will not be able to get gold they have promised.

So backwardation is bullish - and cantango is too, as stated above.
So Buy Gold ;-)

Feb 07 03:01 AM

[Austrian ec...:]

Hello,

Your comment on the oil contango is incorrect. That a forward market is at a huge premium to spot does not on the whole indicate that people will think prices will be higher at the time of expiry. It is related to whether or not the item in question can be hedged.

A 50% premium to spot prices can be arbitraged away by anyone with an oil tanker. Just buy it and sell it one year out for a 50% profit. That is why this 'supercontango' will vanish. If people honestly thought that oil was going to be alot higher in a year's time than now, then they would buy near term forwards, not one year forwards and roll their contracts. The margin requirements would be substantially less... around 50% when you think about it! The 'supercontango' in oil is more related to supressed spot prices due to lack of spot (think economic/time present) demand, rather than future escalated demand.

Why not come and learn about it at Professor Fekete's seminar at the end of March? Go and check his website.



On Feb 02 05:17 AM paultaut wrote:

> I guess I just can't seem to get it into my head how one thing means
> something else for a different commodity.
>
> Oil is in Contango and bullish because the belief is that current
> prices are too low and will be higher in the Future. Here there is
> No current demand but demand is expected to pick up.
>
> Yet Gold/Silver Backwardization is considered Bullish Also even though
> Future's prices are lower. Here you have current demand but the future's
> price indicates that demand is expected to slow.
>
> Could you please explain what the difference is?
>
> As the premium on physical Gold and Silver declines, will that be
> a sign of a reversal in both Commodities?
>
>
>

Feb 16 11:05 AM

[Conan the B...:]

Two months later, Gold is in Contango, has been on the way down and is so now.

Using the contention stated above regarding the Collapse of the Dollar if Gold were to stay in Backwardization for a prolonged period of time, can I assume that this collapse is no longer visible?

Jim Turk and Dr. Fekete both GATA allstars. Ditto Ted Butler who reports that both COMEX and CFTC are under investigation for manipulation and price suppression, yadda yadda..

Considering that the GATA made the filing, it is no surprise that the three of them and now yourself are pushing and pulling the same strings.

Your article, Howard's, Butler, Fekete, Turk...Wow, there are enough of you now linked to each other That I can Opine that you form a Conspiracy to foster your Own Agenda. You wish to promote the theory of Gold/silver manipulation without any proof whatsoever.

When asked, you point to each other as sources.

Who is trying to Manipulate whom? IMHO

Apr 08 02:30 AM

[Jake Towne:]

Pardon me as I will repeat myself from another comment stream but ---

"yes, I am advancing the work GATA has done because I believe I understand their evidence well enough that its not just a theory, its probably fact - central banks want to suppress the price of gold and have acted to do so. The goal from my point of view is public hearings between the US gov't and GATA

The manipulation theory is offered to the public for review as part of a quest for truth, not a quest for conspiracy. Many are still unaware, and the person on the street certainly has little clue, although all these Cash4Gold ads have people thinking a bit."

Conan, here's the source. There is no way I am trying to manipulate you or anyone for that matter, though I understand the reasons behind your insinuation.

In my opinion, everyone should seek the damn truth for themselves, just as you and I have been doing. Its perfectly fine, and even healthy, if we disagree. Now admittedly this is not my work, but if you can reject this evidence point-by-point from the link below I would be interested. Thanks for writing back, appreciate it!

gata.org/node/6519


On Apr 08 02:30 AM Conan the Barbarian wrote:

> Two months later, Gold is in Contango, has been on the way down and
> is so now.
>
> Using the contention stated above regarding the Collapse of the Dollar
> if Gold were to stay in Backwardization for a prolonged period of
> time, can I assume that this collapse is no longer visible?
>
> Jim Turk and Dr. Fekete both GATA allstars. Ditto Ted Butler who
> reports that both COMEX and CFTC are under investigation for manipulation
> and price suppression, yadda yadda..
>
> Considering that the GATA made the filing, it is no surprise that
> the three of them and now yourself are pushing and pulling the same
> strings.
>
> Your article, Howard's, Butler, Fekete, Turk...Wow, there are enough
> of you now linked to each other That I can Opine that you form a
> Conspiracy to foster your Own Agenda. You wish to promote the theory
> of Gold/silver manipulation without any proof whatsoever.
>
> When asked, you point to each other as sources.
>
> Who is trying to Manipulate whom? IMHO
>

Apr 08 09:38 PM