By Trace Mayer, on February 8th, 2011
In the monetary metals there has been sustained gold backwardation and silver backwardation. This esoteric subject distills into two main elements: (1) interest rates and (2) risk management. The backwardation implies abnormalities in the interest rate structure and/or heavy demand for physical bullion driven by either averseness to counter-party risk or exchange rate risk that could result in the currency event of hyperinflation or the paranoid gold and silver bugs have recently mutated into much larger organisms.
READER QUESTION – WHERE ARE YOU?
I have not written for a few weeks and received a rather funny email from a reader: “Did you call this about 15 months ago? POT NYSE You sly Mofo. Where are you? Did someone threaten you like Lindsay Williams was?”
I figure the response may be helpful to all. Yes, about 18 months ago on Business News Network in Canada I did make a buy call on Potash Co. (POT). It has since rocketed higher. I have been bouncing around in the clouds flying around tiny islands, including Saint Kitts and Dominica, with Bill Rounds, my co-author of How To Vanish.
I was only threatened by one person, an attractive female Customers and Border Patrol agent in Puerto Rico. Because ATC diverted us around a military exercise we were late arriving and I did not call. Then on the way back through Puerto Rico I failed to call again and while searching our plane she actually got out a Geiger counter, seriously! What is it with women always wanting you to call them back? So, next time I am headed through Puerto Rico and since my smile did not work to appease her if anyone knows where I can get a cell phone like Gordon Gekko so that I can call CBP next time I would be extremely grateful.
SILVER BACKWARDATION AND INTEREST RATES
The monetary metals have an interest rate which is the percentage difference between the future price and spot price. Currently the market treats only gold as a primarily monetary commodity. Silver, platinum and palladium are treated as quasi-monetary commodities. Gold is produced primarily to be hoarded while most silver, platinum and palladium demand is for a wide variety of industrial uses like a Gordon Gekko cell phone.
In early 2009 I wrote about the silver backwardation. James Turk, Chairman of GoldMoney, made several insightful observations about silver’s backwardation in his 4 December 2010 article about the Scramble For Physical Metal.
These supply and demand differences is a primary reason why I am extremely bullish on platinum and recommended accumulating it in July 2009 around $1,118 per ounce. My opinion is that during The Great Credit Contraction the monetary demand for silver, platinum and palladium will increase for all the same reasons why gold functions as money. It will no longer be fiat currency, such as FRN$, Euros, Yen, British Pounds, etc. versus only gold but instead versus gold and every other commodity.
This paradigm shift from a debt-based consumption cycle to an equity based savings cycle will be a sea change like an upside down house to many. The real interest rates of the commodities are a function of their storage and attrition costs. Thus, silver, platinum and palladium will have tremendous advantages over alternative commodities like rice, corn, oil, etc.
The New York Sun reported Alan Greenspan’s 15 September 2010 remarks to the Council on Foreign Relations:
If all currencies are moving up or down together, the question is: relative to what? Gold is the canary in the coal mine. It signals problems with respect to currency markets. Central banks should pay attention to it. … Fiat money has no place to go but gold.
Like Mr. Greenspan I favor using gold as one’s numeraire but my prognostication is a little broader. Not only does fiat currency have gold to move into but also silver, platinum and palladium unless he knows something about future worldwide monetary policy that has not been publicly released.
With quantitative easing and the zero interest rate environment the fiat currency interest rate structure is extremely distorted. This increases demand for silver in the immediate term because the cost of fiat currency is so low while demand is waning and storage fees are perceived to be less expensive than the estimated counter-party risk cost. It takes a bailed out zombie to know a bailed out zombie!
The net effect are negative real interest rates. So long as negative real interest rates are persistent the gold bull market, with silver and platinum having an R-squared correlation coefficient of about 98%, will remain intact. But as Adrain Douglas has astutely observed if there is increased monetary demand for silver then this correlation can be disrupted or change completely.
INCREASED SILVER MONETARY DEMAND
So an important issue becomes has there been a material increase in silver’s worldwide monetary demand?
The United States Mint recorded January 2011 sales of American Silver Eagles to be 6.42 million which easily surpassed the previous monthly record of 4.26 million in November 2010. This increase in demand was in spite of the price of silver increasing by about $2 per ounce in November while it declined about $3 per ounce in January. Increased demand for silver in India was about 70 million ounces in 2010 while China went from exporting about 40 million ounces in 2009 to importing 40 million ounces in 2010. Then there is John Embry’s revelation that it took about two months to stock the Sprott silver trust. Additionally, there appears to be shortages developing for 100 ounce silver bars.
Because of the increased demand for silver as a monetary instrument by Americans in the form of legal tender coins and 100 ounce bars, the incredible increase in demand from India and China of about 150 million ounce difference between 2009 and 2010, about 25-30% of worldwide production, and the creation of the Sprott silver trust (PHYS) therefore it appears that there is a material and consistent increase in the worldwide demand for silver as a monetary instrument. Because of the deficiencies of the GLD ETF and similar unusual activity with the SLV ETF it is interesting to note that significant redemptions are being made which implies the ETFs are being tapped as a source of physical bullion to meet immediate delivery demands.
The aboveground stockpiles of silver are tiny compared to gold. On the other hand, central banks around the world have created $20-50 trillion of new currency digits over the past few years. To remain liquid and risk-free in terms of either (1) counter-party or (2) hyperinflation, the value represented by these imaginary units sometimes printed on colored coupons have primarily nowhere to go in regards to monetary commodities but gold, silver, platinum and palladium.
CONCLUSION
Monetary demand for silver is primarily from savers who consume less than they produce and want a liquid and safe store of value while they are engaged in other activities, like flying around in the clouds. The current interest rate structure is likely causing headaches for the arbitrageurs dealing in large amounts who are attempting to squeeze profits off a penny or two per ounce because of the tremendous amount of risk they expose themselves to as savers demand delivery physical metal.
With the worldwide bailout of the financial system, the Irish central bank printing billions of Euros, the Federal Reserve engaged in quantitative easing and general competitive currency devaluations worldwide it appears the current fiat currency and fractional reserve banking system has been duck taped together and is not at significant risk of imminent failure; largely because there is no significant alternative.
With demand from the American and European public, India, China and the Sprott silver trust therefore it appears that the gold and silver bugs have mutated into much larger organisms and are preparing for currency upheaval and perhaps even a new worldwide currency system. There is a high probability that gold, silver, platinum and palladium will continue to increase in price relative to fiat currencies.
After all, fiat currencies are merely a confidence game and it is hard to have confidence in a figment of the imagination that is being rapidly increased in amount. Thus, a prudent saver should continue accumulating the monetary metals on a regular and consistent basis from reputable firms like Apmex or GoldMoney as gold, silver, platinum and palladium have become performing insurance against fiat currency failure.
By Bron Suchecki, on August 3rd, 2010
I have a book in my library called The Social Construction of Reality. Its basic thesis is that reality is socially constructed, or to put it another way, reality is what people believe it is. For example, if you moved to a new town and a rumor was circulated that you were an axe murderer, then you can imagine that people would avoid you, police would monitor you and if there was a murder, you would be an immediate suspect. Even though it was not true, you would in effect be experiencing the life of an axe murderer, at least in how people related to you. For you it would become reality because the social group believed it to be true.
You said “But if “smart” dollars of size (or let’s just say all dollars of size) are not getting a bid from real physical gold of size… and only “idiot” dollars are getting a bid from “paper gold”… can we really say the gold basis is reflecting reality?”
My contention is that if the social belief is that paper gold is as good as physical gold then for all intents and purposes it is. As a result the basis reflects that and does not go into backwardation because people are accepting paper gold bids for their dollars. Saying this does not mean I condone it, but while the social belief continues, what the real “level of physical gold’s bid for dollars” is does not matter regarding price.
There is little proof I have for my claim that we are still in phase two of the Degrees of Distrust as the gold market is opaque by nature. One fact I do have is the recent revelation by the Financial Times that the 346t of gold for the BIS swap “came mainly from investors’ deposit accounts at the European commercial banks”. That is 346t of trust by those investors and indicates there are a lot of people who still believe in the system.
I can’t 100% sure where we are at, but would caution against too much optimism. If we are still in phase two then a lot of education is still called for. I think the mass market is still not into gold in any major way and when it does it needs to be directed into products that take real physical off the market. We have to ensure investors are properly informed, that they understand the true “gold reality”. 
By Bron Suchecki, on July 28th, 2010
FOFOA started a little excitement with his post on backwardation. Professor Fekete responded and Zero Hedge weighed in as well.
I would not be surprised that for many this backwardation thing makes their head hurt and perceive it as all very theoretical and of no practical use. But this is not true and backwardation is a potential profit opportunity for those holding gold. However, it is also being overplayed.
Backwardation is when the future price is less than the cash (spot) price. Consider you are a long term holder of gold expecting to sell it in a couple of years when the price peaks. One day you wake up and note that the price of gold six months into the future is being quoted on COMEX at $1150. You check with your local coin dealer and he is quoting to buy your gold at $1200. What does this “backwardation” mean to you? See below (numbers for purposes of calculation simplicity, not real costs).
You work out that it will cost you $100 to ship your 100oz to the dealer. He will pay you $120,000. You deposit $20,000 of that with your broker as margin (plus extra to cover fluctuations) and buy the $1150 futures contract, plus brokerage fee of $50. You deposit the remaining $100,000 cash in the bank for 6 months at 0.5%. On maturity of the futures contract you stand for delivery and incur $50 brokerage and $100 shipment cost. Your profit on this is $4950, composed of
* Sale of gold: +$120,000
* Purchase of gold: -$115,000
* Interest on cash: +$250
* Brokerage and shipment costs: -$300
Now this is a great deal. At the end of the 6 months you still have physical gold but you have earned additional money while you wait for your eventual sale in a couple of years. Why would you not take up this opportunity?
Well, the deal is saying “Sell us your gold now and (trust us) … we will have it to sell back to you in the future for less!” You are exchanging your current physical gold for a future claim to gold. You have “counterparty risk”, to COMEX, to the short on the other end of your 6 month futures contract.
Of course, such a wide difference between cash and futures prices does not normally occur, because faster and bigger players see the profit opportunity and get in first. Their action of selling lowers the $1200 cash price and their buying of the 6 month futures increases the $1150 price and thus eventually the gap (and profit) disappears. That is arbitrage.
But if you did see such a big difference in prices, it means the big players aren’t taking up the deal. The cash-futures gap is telling you that people don’t trust COMEX, they don’t think they’ll get their gold back in the future. What backwardation is telling you is that people don’t want to give up their gold, even for a little while. As FOFOA says: “gold stops bidding for dollars”.
This leads to my closing point, which is best summed up by Tom Szabo’s December 2008 comment: “Let’s talk if and when the backwardation is large enough that the arbitrage was there and yet still nobody chose to go after it. That would be truly something!”
For example, if the cash price was $1200 and 6 months futures $1199.25, in my simplistic (and unrealistic from a cost point of view) example, that would mean a profit of $25. That is technically backwardation and technically a profitable one. But could you (or the big players) be bothered with all the work involved in selling gold, buying futures and then taking delivery, all for $0.25 per ounce profit?
Therefore, the only backwardation that matters to me is backwardation that:
a) means reasonable profit and
b) no one is willing to take that profit (that is, it is persistent).
Any other backwardation is just noise and has no “information value” by itself.
If this topic interests you, the following two services specialise in tracking the gap between cash and futures (known as the “basis”):
The Metal Augmentor (Tom Szabo)
Gold Basis Service London (Sandeep Jaitly)
These services look at the bigger picture and don’t get distracted by instances of technical backwardation. They look at the trend in the basis, trying to identify in advance when significant and persistent backwardation will occur. 
By Trace Mayer, on February 25th, 2010
Operating a website requires monitoring to make sure there are no problems but doing so can uncover very interesting nuggets of information. For example, on 24 February 2010 at 11:15 EST in the evening someone at Goldman Sachs Company in the main NYC office found RunToGold through Google by searching for the phrase ‘buying silver‘.
 Gee, I wonder who that someone was and what they are thinking. Originally, I was thinking of posting their home address, picture, resume, social security number and other websites they visited but they are not safe for work and considering the hostile feelings towards the company I decided against the personal information. But Eric Schmidt, CEO of Google, would probably not mind considering his statement to Maria Bartiromo:
I think judgment matters. If you have something that you don’t want anyone to know, maybe you shouldn’t be doing it in the first place. If you really need that kind of privacy, the reality is that search engines — including Google — do retain this information for some time and it’s important, for example, that we are all subject in the United States to the Patriot Act and it is possible that all that information could be made available to the authorities.
BUYING SILVER INTENT
The brilliance of the Google Superbowl ad was in its ability to communicate an entire story with only a few lines of text.
Truly, one’s search patterns can reveal intentions. Now, what can be discerned by these virtual footprints from one of Goldman Sachs’ 36,000+ employees? Conclusively, probably not much and we (NSA) would need access to more transactional databases and the passage of S. 733 the Cybersecurity Act of 2009 but we can still speculate about talk around the water cooler or higher order drama. Who knows if that someone was the secretary, their boss or both. It was 11:15PM after all!
SILVER BACKWARDATION CLOSE
Lately I have not followed the SIFO rates closely so this was my initial suspicion and once again it appears that silver is nearing backwardation. While the paper silver market which has an unlimited supply of silver and the physical silver market is constrained by actual metal the fractures between the two are beginning to emerge again.
In 2009 I chronicled the silver backwardation that led to a 60% rise in silver prices over a seven month period. Additionally, the gold to silver ratio has moved over 10% in less than two months. With silver recently slipping below its 200dma it is becoming a good value. But with silver getting cheaper this move in the ratio portends a slowing of the precious metals bull. And so there are conflicting signals.
CFTC SILVER MARKET INVESTIGATION
The slide towards backwardation is particularly enthralling given the CFTC’s three investigations of the silver market in five years. Ironically, silver analyst Ted Butler who has been particularly vehement of the CFTC’s faux investigations seems to like the new Chairman Gensler and on 10 February 2010 wrote,
I have been unabashed in my praise for Chairman Gensler since the time he assumed office. I have called him the greatest chairman in CFTC history. … I understand that disagreement [with the praise]. Yes, he was a partner of Goldman Sachs, the dreaded “vampire squid” of the financial world. Yes, he was a participant in the deregulation of 2000, which added greatly to the financial crises of the past couple of years. Yes, he is an “insider,” with connections and access to those in power.
What could Goldman Sachs know about the silver market, what might be being discussed around the water cooler and how might Chairman Gensler’s influence with his old cronies play into this?
CONCLUSION
The digital world offers tremendous opportunity to covertly monitor and draw inferences. In this case, someone at Goldman Sachs was researching about buying silver and they could have easily cloaked their behavior with anonymous web surfing. Imagine the latent power Google and the NSA have and would using it constitute ‘insider trading‘?
Yet, a former Goldman Sachs employee is the CFTC chairman who is embarking on the third investigation of the market in five years while the metal drifts towards backwardation. The paper price of gold and silver may be drifting lower but the physical silver is getting cheaper and a better value.
If you do not have a core position, to protect against the Laboon of sovereign debt defaults, negative FDIC funds, quantitative easing, etc. then yesterday was when you should have acquired. If you already have a core position then it may good to wait a little while longer for even better silver prices such as 0.95x the 200dma.
Order the new Bank Privacy Report before the end of February and get 50% off.
DISCLOSURES: Long physical gold and silver with no interest in sovereign debt from Greece, Portugal, Italy, Ireland, Spain, etc., GS, or the problematic SLV, Streettracks Gold ETF Trust Shares or the platinum ETFs.
By Trace Mayer, on September 14th, 2009
The silver backwardation has been on-again off-again throughout 2009 and this portends gigantic problems for the worldwide monetary system. Backwardation is a situation where the fiat currency price of a commodity is pregnant with a premium the buyer is willing to pay for immediate delivery. The price of a commodity for future deliver is lower than the spot price. This is contrasted with contango where the spot price is lower than the futures price. Backwardation seldom arises in the monetary commodity gold or the quasi-monetary commodity silver.
QUESTIONS
The depth of one’s intellect can usually be answered by the questions one asks. In our family we have a couple jokes. For example, ‘How big is yellow?’ And, ‘How many kids with ADD does it take to screw in a light bulb? Wanna go ride bikes?’
As my articles are widely syndicated throughout the Internet it is interesting to see the comments they receive. I really wish I had the time to read them all and respond, which I do occasionally, but there are more important things to do. But in preparing this article I decided to review some of the comments from my earlier articles and found it quite humorous.
For example, on 25 Feburary 2009 Cesato remarked, “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”. On 25 February 2009 silver closed at $13.81 and by 11 September 2009 the backwardation had ended and silver closed at $16.77, a 21.4% gain or a 39.5% annualized rate when measured with the undefinable dollar.
On my article ‘How the Treasury Bubble Will Burst and Why‘ at Seeking Alpha I received a comment from Alan Brochstein, CFA and fellow Seeking Alpha Gold Standard Contributor who provides analytical services for hire. He said, “Trace, sorry, but this makes absolutely no sense…” This is not surprising considering his 8 Dec 2008 article ‘Own Gold? Time to Fold‘ where he stated, “Gold remains a sucker’s bet…” On 8 December 2008 gold closed at $772.25 and by 11 September 2009 gold closed at $1,005.70, a 30.2% gain or a 39.8% annualized rate.
In February 2009 after I observed about two week’s worth of silver backwardation I then proceeded to ask and answer this question:
What if silver trades in backwardation for an extended period? Well, I already answered this question earlier. It means individuals are unwilling to take the risk of holding national currency illusions or the risk of an exchange’s failure to deliver. Potentially the national currency illusions could be pulled into the event horizon leading to the fiat currency graveyard.
The fundamental outlook for the FRN$ has gotten even worse, although there is a case for the FRN$ to rise, and the potential for a COMEX gold or silver delivery failure is a constant specter.
BACKWARDATION SPECTER RISING
The specter of backwardation is rising. The COMEX contracts for Sep 2009 and Oct 2009 had the same settlement price.
Likewise the London SIFO, the Silver Forward Mid Rates, have been trending towards backwardation.
 Additionally, the LIBOR-SIFO is moving toward dangerous territory.
 While silver has not settled into backwardation yet this will be an important trend to watch. Having the physical metal in one’s possession or with a trusted third party like GoldMoney gaining in importance. I would be particularly wary of unallocated gold or silver accounts. Usually silver is a very quiet metal. But when it moves, it moves! About 90% of silver’s price movement happens in 10% of the time.
SILVER IS RELATIVELY CHEAP
SILVER INVESTING GUIDES
For those that are new to the silver market and are considering how to buy silver an excellent book is from Mr. David Morgan of Silver-Investor called Get The Skinny On Silver Investing or Mr. Michael Maloney’s Guide To Investing In Gold And Silver.
CONCLUSION
At all times and in all circumstances gold, silver and platinum remain money. The silver market is miniscule compared to the amount of total tangible and financial assets in the world. Yet silver can never become worthless because it is a tangible asset. As capital continues seeking a safe and liquid home silver is among the beneficiaries. With the Chinese and Indian acquisition of physical silver there will be even more strain on the paper markets for delivery. While silver is currently not as cheap as it was earlier when I recommended buying; the ‘tears of the moon’ is still a decent value.
DISCLOSURES: Long physical gold, silver and platinum with no position in the problematic GLD or SLV ETFs.
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