It’s pretty clear that the market for silver has been showing signs of significant supply/demand imbalances. You can see that in the price for silver itself, but what adds context to understanding this market is its contango.
The contango for a commodity simply shows the difference between the price for delivery of in the near term vs. the price for delivery later, say a year from now.
Usually the price for delivery of an ounce of silver a year from now would be higher than the current spot price. That’s understandable. After all, if you’re selling that silver, you’d want a higher price for storing it. If you’re the buyer, you’d expect to pay some sort of premium because you’re not comitting the capital to take delivery right now.
For example, here’s a look at the contango for silver from December 2007 through July of 2008 – just before the financial crisis.
click to enlarge
The chart with the grey lines shows the difference between various contracts for future delivery vs. the front month contact. The slightly darker line at the top shows the futures contracts with about a year until delivery.
As you can see, in December 2007 the price for delivery in roughly a year was almost $1 per ounce more than the front month contract, but that premium shrank to about 60 cents by March as silver was rising.. This is normal as the contango will often contract as prices rise, then expand as prices fall.
Backwardation: A negative storage premium
When demand for a commodity gets exceedingly high and/or supplies are extremely tight, the storage premium can vanish. And in some cases the contango becomes negative – a condition called backwardation.
When a market is in backwardation, the price for delivery now becomes higher than the price for delivery later. A negative storage premium for silver implies that buyers would rather get their silver right away even if they could pay less for delivery later.
This is generally rare for a precious metal like silver. Take a look at the contango from September 2010 to April 4, 2011.
In September, the market was in contango, but the premium for delivery about a year into the future was only about 20 to 40 cents per ounce. In February, the market slipped into backwardation.
Backwardation is generally a bullish sign. After all, why would someone be willing to buy or sell silver at a lower price several months from now? That doesn’t make any sense unless there’s a lot of pressure for silver to come out of storage.
But even if the market goes back into contango, that does not necessarily mean that the price of silver will fall. However, I will point out that if you see a rapid rise in the contango, that implies that at least a short-term top may be in place.
As I mentioned, a flat to negative storage premium for a metal like silver is fairly rare, so it will be interesting to see how this all plays out in the weeks ahead.
Disclosure: I am long SLV.
