For the past week or two, the price of platinum at the NYMEX futures exchange has gone into repeated transient episodes of backwardation. As this author has explained in past articles, backwardation in a precious metal usually means that a shortage exists in the marketplace, and hidden momentum is building for a very strong upward movement.
Platinum for July delivery is being offered at a higher "ask" price than platinum offered for the next major delivery month, which is October. For example, as of 08/15/2011 at 11:08:19 AM eastern time, the futures market's "spot" price for July, 2011 delivery, was $1,761.20 and $1,763.50. The bid and ask for August delivery was $1,777.60 and $1,782.60, some $15-20 higher. But, the bid and ask for October delivery, which should be higher than both July and August, was only $1,762.80 and $1,763.20, which is close to, but $0.30 lower on the "asking price" than July delivery, and $15 to $20 lower than August. The situation described has existed to a greater or lesser extent at various different pricing points, for quite a few days.
It is difficult to access this situation. Apparently, short selling banks are not eager to deliver platinum in August, though there were buyers willing to pay a significant premium for them to do so. If sellers believed that enough platinum is going to be available in October to be certain that there won't be a default in delivery, they would sell for August delivery, buy for October delivery, and pocket the cash difference. Yet, the bid prices remained on the ticker for hours at a time, unaccepted. Finally, by the end of the day, short selling banks apparently were finally embarrassed into accepting four of the bids, and the open interest for August rose from one contract up to five that day.
The most important question is what caused this pricing anomaly to continue for so long? Careful observation of selling trends at the futures markets, over many years, does show that buyers of precious metals futures contracts, who are targeting off-month delivery periods, such as next August, are unconcerned with low liquidity. That is because they almost always intend to take physical delivery. Short sellers, being experts in their field, know this. They probably realized that any contracts they sold for August delivery would need to be delivered. They hesitated for a very long time, up to the point where a failure to accept the bids would have alerted the broader market to a problem they may want to keep secret.
The fact that the short-selling banks and hedge funds were so hesitant about selling August contracts while being willing to sell much cheaper for October delivery, tends to indicate a shortage is expected in August. A shortage which they hope to have resolved, at least in part, by October. The asking price for October, however, was not only lower than August, but also lower than the asking price for spot delivery in July, during most of the last few trading days. That tends to indicate that short sellers are not confident about a resolution by October. Probably, they are now experiencing difficulty in sourcing metal, at the alleged spot price.
The probability is that short selling financial institutions are offering low July asking prices, even in the face of these difficulties, to ensure that the futures markets serve as a price control mechanism. Price control involves public perception that the fantasy price, created by them at the futures exchanges, is actually the real price arrived at by so-called "price discovery". Getting people to accept the fantasy price and sell them metal for delivery, at that fantasy price, involves making sure that public perception is manipulated. These perceptions are influenced most by reported prices in the more popular delivery months (which, in platinum, are July and October, 2011), and not so much by off-months (like August 2011). That is probably why they are willing to risk even larger delivery obligations in July, while hesitating to accept even very generous offers for August.
There is a balance between the risk of increased spot delivery demand, and keeping the prices controlled. Manipulative short sellers care less about the off-month August contract because it is rarely reported by the media. The headline numbers emphasize the spot month, and the next major contract month, meaning July and October, 2011. Offering cheap July futures prices helps the banks buy physical metal at cheaper prices in July, to compete deliveries, but is offset by the possibility that delivery-oriented cash buyers might be attracted enough to buy at the futures exchanges, rather than in the physical markets. But, failure to accept 4-5 offers (200-250 troy ounces), pending all day long, offering $15-20 more than the October price, simply in exchange for an August delivery, would have alerted the broader market to the real situation. So, finally, the offers had to be accepted.
The case for a sudden massive upward movement is not as strong with platinum now as it was with silver, in our articles from February, 2011, and March 2009. However, the "pseudo-backwardation" in platinum prices implies a shortage of physical platinum that short sellers may be trying to hide. It implies a strong probability that there will be a significant rise in platinum prices not too far in the future. Platinum is an inflation hedge and has no counter-party risk, just like gold and silver. Big players such as JP Morgan Chase (NYSE:JPM) and Deutsche Bank (NYSE:DB) are buying. The potential downside is platinum's status as an industrial metal. But, any loss of auto catalyst demand will be more than offset by the fact that platinum jewelry sales dramatically increase as gold prices rise. We have already seen platinum jewelry sales increase anywhere from 80% in China to 40% in North America and the U.K. during the first quarter of 2011. That is probably what is causing the current shortage.
Given that the mining supply of platinum is only 1/15th that of gold, and that very little above-ground supply exists, jewelry market substitution can and probably is creating a shortage that short sellers would like to hide from the rest of the market until it suits them to allow the price to rise (such as after they finish buying metal for deliveries). Then, when the price rises enough, perhaps into the low to mid $2,000s per ounce, they can justify the opening of a lot of new, potentially profitable short positions. With platinum only $170 per ounce higher than gold, and with the ratio in normal times being 2-2.5 to 1 against gold, it is likely to appreciate more quickly. Platinum can be bought in the form of an ETF (NYSEARCA:PPLT), physical coins or bars and/or a host of platinum mining stocks such as Lonmin (OTCPK:LNMIY) or Anglo-American (OTCPK:AAUKY).
When considering equities, keep in mind the potential of excessive executive compensation, management errors, political risks and electricity shortages that the commodity, itself, does not share.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.