Five Weeks of Silver Backwardation

During an interview with Contrary Investors Cafe on 24 February 2009 I discussed both gold backwardation and silver backwardation. After the interview I was asked why more commentators are not discussing this issue. I do not know.

Regarding money there are two competing views: (1) money is determined by the market or (2) chartalism which asserts that ‘money is a creature of law.’ Governments can only manage money if they create it. Obviously, the market determines money because money existed before governments were created.

Regarding gold there are two competing paradigms: (1) gold is a commodity and (2) gold is money. Paradigm (1) asserts that gold is a hedge against inflation and there is no monetary demand for gold. On the other hand, paradigm (2) asserts that gold is a hedge against currency collapse and the primary demand for gold is monetary. I subscribe to the second paradigm and assert that at all times and in all circumstances gold remains money.

WHAT IS SILVER’S ROLE

Under which paradigm does silver fall? Is silver a commodity or is silver money? For a commodity to be money its primary demand must be monetary.

Like gold, for thousands of years silver functioned as money in the market. The term dollar, as used in Article 1 Section 9 Clause 1 and the Seventh Amendment of the US Constitution, is defined as 371.25 grains of fine silver under Section 9 of the Coinage Act of 1792. Governments stockpiled billions and billions of ounces. However, on 24 June 1968 the United States government defaulted on their silver certificates. Over the decades, silver, like gold, has been demonetized in ordinary daily transactions. Supposedly there are large stockpiles of gold in central bank vaults. Unlike gold there are no reported large above ground stockpiles of silver stashed in central bank vaults. Additionally, a large portion of silver demand is industrial as it is used in cell phones, refrigerators, dental equipment, computers, etc.

Therefore, it appears that silver is confused about its role. In other words, silver functions as a commodity and as quasi-money.

FIVE WEEKS OF SILVER BACKWARDATION

While similar, there are differences between future and forward contracts. For example, future contracts are traded on exchanges, use margin and are marked to market daily. In contrast, forward contracts are generally traded over-the-counter (OTC derivatives) and are not marked to market. Therefore, forward contracts are subject to greater counter-party risk than future contracts.

Because the primary reason backwardation arises is counter-party risk and because forward contracts are impregnated with greater counter-party risk than future contracts, therefore it is highly likely that backwardation would appear in the forwards markets before the futures markets.

This is precisely what has happened. While the COMEX silver futures contract have not been in backwardation the LBMA Silver Forward Mid Rates have been in backwardation for five consecutive weeks. Of particular interest is the 6 month contract.

SO WHAT?

What does all this mean? Well, I think the backwardation reflects the market’s uncertainty of silver’s role as money. The chronic silver backwardation began on 8 December 2009, the same day I wrote about gold in backwardation, and silver was priced about $9.60. Currently silver is trading about $13.82. Predictably, the gold/silver ratio is narrowing. If the backwardation persists it will be interesting to see if silver’s price in illusory FRN$ continues rising.

In my opinion, as the great credit contraction grinds on and intensifies, the commodity silver will reassert itself as money and eventually currency. As I mentioned during the interview with Contrary Investors Cafe what would be really interesting is if the central banks decide to start hoarding silver!

In the meantime it may behoove those who are bullish towards silver to increase the pressure on physical silver delivery. For example, I purchased some beautiful Austrian philharmonics at the Cambridge House Investment Conference and Silver Summit over the weekend. The beautiful coin cost $20 which was an amazing $5.50 over spot.

While there are cheaper ways to purchase physical silver bullion, like GoldMoney, these huge premiums over spot beg the question: What is the real silver price? With the specter of counter-party risk driving silver into backwardation if there is a failure to deliver then it will likely cause the silver price to shift from the COMEX just like a failure to deliver would cause the gold price to shift from the COMEX.

Bottom line: Do not get caught with your paradigms down!

Comments

[User 292572:]

>For example, I purchased some beautiful Austrian philharmonics at the >Cambridge House Investment Conference and Silver Summit over the >weekend. The beautiful coin cost $20 which was an amazing $5.50 over >spot.

I am surprised that you, as a silver expert, don't know how to buy silver coins! At kitco.com, Philharmonic silver coins are only $2.4 over spot and still available. Also check apmex.com.

Feb 25 08:04 AM

[odessa88:]

"I am surprised that you, as a silver expert, don't know how to buy silver coins! At kitco.com, Philharmonic silver coins are only $2.4 over spot and still available. Also check apmex.com"

I have always used apmex and have never had any issues with them at all.
Highly recommended.

Feb 25 09:13 AM

[SW Richmond:]

Trace,

You said "gold is a hedge against currency collapse".

This is in error. In fact, all you needed to say was "gold is a hedge against currency". The "collapse" part is given.

:)

Feb 25 09:39 AM

[philais:]

Yep, the Austrian Philharmonics are a beautiful coin! They we're my first foray into bullion.

It is amazing that the market is willing to buy into the premiums demanded.

But, the psychology and pleasure of holding 50 oz's of pure .999 silver bullion Austrian Philharmonic's at $20 ea. versus a single 1 oz $1000 Gold Philharmonic is overpowering!

Feb 25 10:22 AM

[Cesato:]

In my experience backwardation has sooner or later led to a price collapse in any commodity. I've never been a long term buyer when a commodity is in backwardation, I do buy in that condition but only short term for the very same aforementioned reason.

Feb 25 10:25 AM

[heartbone:]

"Therefore, it appears that silver is confused about its role."

???

I would not consider that statement to be confused because statements are not alive.

Feb 25 10:55 AM

[ROLEXDAYTONA:]

Al silver demand will be filled no problem, companies can't get any $$$ from banks and investors, they are cash strapped and fight for survival, that's why hedging in GC and SI is back again, hedging has such a power that will depress this market hard.
It's like suicide, there is no escape.

Feb 25 01:42 PM

[GMiki1:]

Regarding backwardation, there are two opinions, apparently. A lot of analysts take precious metals backwardation as extremely bullish. Silver is certainly a tight market, much tighter than gold. I read Ted Butler--he's the premier, in-depth analyst of the silver market and he has some very interesting opinions.

Feb 25 02:32 PM

[jimmy46:]

on 24 June 1968 the United States government defaulted on their silver certificates""""""""""

You are in error here, the gov. had a tender offer that expired that date,
anyone who tendered before the date got the silver.

Feb 25 03:08 PM

[SugarDaddy:]

The day any of the Central Banks make any attempt to hoard silver is the day I get into the trucking business, cause they would need to lease a gigantic fleet of em, to make any difference ROFL

Feb 25 11:56 PM

[know nothing:]

Can you say stress test? Wait until the results are in, you may wish you never knew the answer to the bank stress test! I don't see anyone giving Silver or Gold a stress test! Some of you act like you have never been in a bull market before? Oh, thats right, most people trade stocks, that explains it!

Never had a retracement in the stock market!

Feb 26 09:30 AM

[5142152-337:]

GMiki: Your comment deserves 1000 thumbs-up since it was short, but powerful, and absolutely correct. Anyone desiring enlightenment on the subject of silver MUST read Ted Butler at butlerresearch.com/arc...

Keep writing lucid factual information GMiki!

Feb 26 01:24 PM

[geewow:]

"The chronic silver backwardization began on 8 Dec. 2009"? You meant to say 2008 didn't you?

Now, didn't FDR make the holding of gold illegal once he took office? Is that possible again, if a depression hits us and gold breaks through the ceiling?

Feb 26 10:09 PM

[Mad Hedge F...:]

ab $$ With gold bugs, survivalists, and garden variety hedge funds running victory laps over the yellow metal’s recent breach of $1,000, it is easy to miss the move in silver that has been twice as impressive. Silver has run 30% this year to $14.60 an ounce, despite the steady deterioration in industrial demand. Silver ETF buying has exploded by 1,676 tonnes to bring their total to 9,929 tonnes. Sales of silver American eagle coins have doubled to four million ounces so far this year. The metal may have more to run. Hedge fund longs, which peaked last year at 50,000 futures contracts, have so far reached only 23,100 contracts in this round. But risk managers are going to have to keep an extra sharp eye on silver positions. A turnaround by the Dow or the yen against the dollar could suddenly take the air out of this bubble.

Feb 27 02:09 PM

[Conan the B...:]

Mad: haven't you bought your Obama Commemorative Yet?

American eagle silver coins are being used, only $19.99 each.

There is your Demand.


More commentators are not discussing "Backwardation" but you do not know why?

How many commentators even know the word, let alone discuss it.

Are there even 5?

Feb 27 04:14 PM

[Conan the B...:]

Backwardation very seldom arises in money commodities like gold and silver. In the early 1980s, there was a one-day backwardation in silver when some metal was physically moved between Comex and CBOT warehouses. (Wikipedia.)

This is Why No one will ever find any historical data to support your Backwardation Theory. There isn't any.

Meanwhile "chartalism", where did you encounter your definition.(your second paragraph.) I hunted and pecked throgh the Wikiped but could not find that particular definition.

Barter was used before the creation of Political/tribal units and is still used instead of money around the world including the USA, "I'll paint your house if you fix my car."

"For a Commodity to be money, its primary demand has to be monetary."

Gold did not fall into this category until Governments were created and deemed that it had monetary value, probably because of scarcity (and the lack of printing presses) in some regions of the world. Certainly not in South America with its "Cities of Gold".

Salt by weight served as money as did rice, and so did other commodities whose Primary Purpose was not monetary throughout the History of Man. But, at the time, it was equivalent to money and was used as such for trade.

Gold was shiney and ornamental before it ever had any monetary value. Wikipedia: "It may have been the first metal used by humans and was valued for ornamentation and for rituals. Egyptian hieroglyphs from as early as 2,600 BC describe gold, which King Tushratta of the Mitanni claimed was "more plentiful than dirt" in Egypt.

You have a theory with nothing to back it up. Backwardation as applied to Gold and Silver, existed for all of One day for silver and momentarily(hours) for gold, since 1972.

The condition did not exist prior to 2007.

Feb 27 07:12 PM

[Conan the B...:]

Trace Mayer: As far as I'm concerned, You took a comment made by "Nowhereman" on Nov. 22nd, 2008 in an article about the "$3.5 Billion Saudi Gold Risk..." and plagiarized his Idea.

He said that he had noticed that spot gold had been trading above the futures. And that in the future he would know what it meant.

A little over two weeks later. You came out with your first Article. Gold in Backwardation.

Since I am Nowhereman, I have taken umbrage.

Feb 28 01:56 AM