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Gold move not confirmed by backwardation
Gold move not confirmed by backwardation
by Project Mayhem
*edit 10/07: I just received information that gold may actually be in backwardation after all, though the market signal may be disguised. See note by Rob Kirby at end of article.
The past two days have seen rather astonishing moves in gold , to a new 18 month high. This article is to briefly serve as a warning. I first want to say that this would not be possible without the brilliant work of Dr. Antal Fekete. I suggest you review his articles if you are not familiar with the concepts of the gold basis or with the concepts of contango and backwardation in a monetary commodity.
Dr. Antal Fekete's articles
http://www.professorfekete.com/articles.asp
This morning I received confirmation that the gold is NOT in backwardation. It is in contango. That is, the spot market price remains below the near-futures price. This means that the move in gold, although rather forceful, does not yet indicate the level of systemic crisis many of us have been expecting. I am writing this primarily to warn leveraged traders to exercise caution at this juncture , as there may be significant downside risk.
I am writing this from a position of a huge gold bull. I do not want to discourage anyone from buying gold. If you do not own gold, you would be wise to buy some of the physical metal immediately, while it is still available. However, that said, this particular move has not been confirmed to the level of crisis that many are suggesting. At least not yet.
Gold backwardation is determined by the difference between the spot price of gold and the nearest futures contract, not the difference between adjacent futures contracts. In this case, in any geographical location, we calculate the difference between the bid price for the physical metal in cash (spot) and the ask price for a near-futures contract. This number is called the gold basis.
Gold_basis(t) = Gold_nearFuture_ask(t) - Gold_spot_bid(t)
where t is a given point in time.
You must also compare at the same geographical location. For example, you cannot compare New York spot bid to Tokyo futures ask.. You must compare New York spot to New York futures, etc.
The gold basis indicates confidence in the futures markets. For example, if the gold basis is negative ,this is 'risk-free' profit for any holder of gold. For example , if the spot bid price of gold is $1000 but the futures ask price is $900, this means I can sell an ounce of my gold at $1000 into the cash market , buy a December futures contract for delivery at $900, and pocket the $100 difference (as well as get my gold back by waiting a couple of months). The only risk here is if there is a force majeure or currency crisis in the meantime, while I am waiting for delivery.
In any case, if the Gold_basis(t) is POSITIVE, this indicates continued faith in the futures market to deliver on its gold promises. If the Gold_basis(t) is NEGATIVE, this indicates a monetary warning signal -- the idea that traders are afraid that there may be default in the futures market, such as a force majeure and cash settlement. A failure of the gold futures market would constitute an international monetary crisis of the highest magnitude, as it would halt dollar-oil pricing as well as international dollar-based trade.
That said, this is NOT the case at the present time. The gold basis has been in fact steadily increasing from near zero in previous weeks, indicating a bearish signal for gold, at least short term. This could change on a dime, especially under conditions of any sort of crisis (flu pandemic, war with Iran, etc), but I felt it was prudent to write this article considering the levels of gold bullishness at the present time.
To confirm international monetary breakdown and gold launch into orbit, I would need to see the following:
1) Gold price firm despite equity declines, aka. a diminishing correlation coefficient with the equity market.
2) Gold basis vanishing towards zero again, or a turn negative in the gold basis.
Here is the email I received this morning with my European source regarding the gold basis:
"Hi [Project Mayhem],
No gold is not in a backwardation and neither is silver. The carry available is + 0.26% for gold viz the December contract and +0.08% for silver viz the December contract as well. Spot gold is 1035.70 and silver 17.165. These are all very bearish signs indeed. We have gone from a state in both markets where there was no carry available to positive carry a few weeks ago. Gold is more likely to fall $200 here than rise.."
While I disagree with my source regarding the direction of the current gold move (I believe we now have a confirmed breakout), I have written this article so people learn about and become familiar with the gold basis. I believe the current gold move does not signal the US dollar death spasm, at least not yet. Perhaps the fate of the US Dollar will become more clear over the next few weeks and months. The gold basis, as a signal, is very important for identifying and understanding 'end game' considerations in the global currency markets.
*edit 10/07: commentary from Rob Kirby:
"I want to let you all know that there is a VERY important corollary to my earlier fast blast. I’ve been told that players requesting physical metal in settlement have been offered significant “off-market” fiat premiums if they would settle in fiat rather than physical. The implications here folks are HUGE: it means that gold is ACTUALLY IN BACKWARDATION NOW.
I say this because, Antal Fekete has just come out with a piece saying the gold price break-out is not confirmed because there is no backwardation in the gold price.
His assumptions are false – gold “IS” in backwardation NOW and it’s being hidden from us."
»
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Its 5:30 PM, do you know where the gold basis is?
I´m currently leveraged long gold just because that´s how my techical system works (and not terribly leveraged at the moment, will get longer if this pattern holds up).
I think you´re great for writing this because its true, the gold basis is probably the single most important secondary (non-price) number for people to keep tabs on, more than even M2 or unemployment (which are fudged anyway). When the gold basis closes negative and under its 8-week average then I´ll say, ok, emergency measurements, get out of all US bank deposits and into gold held in Zurich or something (I live in Argentina and am holding a small amount of physical gold, but I wouldn´t bother with holding a 100oz bar around here for security reasons).
Gold in Contango tells me that this rally is mostly due to short-covering and "buy high, sell higher" action in the futures market and is therefore technical in nature, profit taking will take its course when the waves get duly extended, perhaps somewhere between 1080 and 1130. I still think gold is going to $850 again before the Cycle wave 3 begins. Hugh Hendry thinks he could get it for $500 but I think that´s posh.
UN calls for new reserve currency
The United Nations called on Tuesday for a new global reserve currency to end dollar supremacy which has allowed the United States the "privilege" of building a huge trade deficit.
http://www.breitbart.com/article.php?id=CNG.e272eaa74dccc30f21c6ff7638b0f37b.461&show_article=1
Gold not going into backwardation is not a bearish sign per-se, its just not bullish... lease rates (1-3 mo) have stayed negative for a while now(while gold rallied) and have actually been moving back towards positive territory as there has been some inversion in the rates. The forward rate/basis has dropped, but LIBOR has dropped faster so you've gotten neg lease rates and a glut of metal to be swapped/lent short-term. This is the markets natural way of correcting a rise in the price, adducing people to sell forward and mop up the glut of gold. BUT, people are not taking the bait and continue to buy forward(lend/swap gold for cash). Think of the incentive there is to borrow gold at neg rates and sell into the market at these "high" prices.
If you look solely at carry rates vs. interest rates you'll miss the bigger picture; the only time the basis becomes important is when it drops significantly lower than rates and the market starts begging people to lend their metal at more and more advantageous rates. That or a break between the technical basis(futures-spot) and the gold swap rate(GOFO) would indicate metal going into hiding/distrust of the COMEX. As mentioned there's no need getting excited about the basis until you start to see lease rates spike.
And if you don't own a central bank vault or a mining company this is useful for?
Man Tyler is popping up everywhere.
http://ftalphaville.ft.com/blog/2009/06/22/58316/libor-is-useless/
+1
Wow great comments.
those are truly thought provoking insights from op....
need to work them over a bit...
i wonder what fekete's take on his analysis....
do you have any way to engage him on this subject?
bless you for posting this....the imf gold sales were scheduled to ward off backwardation and that will keep us above water for a while...
however, that does not mean that gold is in for a fall....it could be but not necessarily....but i always consider it that dollars rise and fall - not gold....gold is the standard against which all else should be measured....
what is your net worth - in ounces? that is the way you measure wealth....
the imf gold sales were scheduled to ward off backwardation and that will keep us above water for a while
I also believe this is the case.
+1
They need to deliver to China's new Hong Kong facility, or so it seems to me.
No backwardation..., till next time.
Hey guys, isn't the usual representation of the formula:
Gold_basis(t) = Gold_nearFuture_bid(t) - Gold_spot_ask(t), with Contango being a positive basis?...
So if you can buy cash gold spot and then sell (paper gold) forward to make a greater yield than LIBOR you make arbitrage profit, so the basis traditionally did not move greatly from interest rates.
Backwardation (negative basis) signifies that people are not willing to part with their physical gold because they think that although selling at spot and buying back at a cheaper futures looks theorerically possible, delivery wont actually happen. Thus the higher spot than futures price....
Suggest you look at http://chasegalleryconnect.org/FNC_C/Data/Personal%20Finance,%20Investin...
You are exactly right , I fixed that. . . My sign was inverted. Thanks!
As for using the futures ask and spot bid (as opposed to futures bid and spot ask), I am not 100% sure. I used my correspondence with my European source , and I think the proper calculation is between futures ask and spot bid.
"[Project Mayhem], Yes you have to use spot bid and future offer at exactly the same time to get the calculation. Gold spot trading is actually 24hrs the same as foreign exchange. The pit hours 8.20 to 1.30 PM EST. Electronic bids and offer are left and traded 24hrs on the comex."
Project Mayhem, I'm not surprised that you used the negative of Dr. Fekete's definition of basis.
Please see the web page at
http://chasegalleryconnect.org/FNC_C/Data/Personal%20Finance,%20Investin...
to understand how entrenched this definitional confusion has become!
-Fred Chase (Frederick N. Chase)
Down $200? You may be long term bullish on gold, but for now, you sound like a trapped short.
I'm unleveraged long. That comment was from my European source . He is gold-neutral I think.
It's his source trapped short, not him.
Did anyone else find the timing of the yesterday's new currency article all too convenient for POG?
After yesterday, I was wondering what could happen that could propel gold through the old highs, and this little gem hits the wire.
I know some here follow the GoldenJackass (myself included), and he was right on the money about the proposed new oil currency, with a backing of gold. I believe he was also right about a progression of events, and I believe this release could very well be one of them. For this info to be leaked right before new all time highs, just too much of a coincidence for me.
What currency article?
i follow willie myself and think that on balance
he is well connected and has made a lot of good
calls....
on the other hand he called for a major take down
at comex gold in september which never occurred so
i have to discount some claims he makes....
i agree with his over all assessment of the financial
state of affairs and general corruption in government
and wall street firms....
I like irreverence and irreverent people and for that reason I started following the GoldenJackass (don't you just love the name? LOL!), and have been a fan ever since.
He said contango.
NATGAS: Take a look at Natural Gas whereas spot is trading almost 50% LOWER than the Nov/Dec futures. Fundamentals in this market are worse.
Not dissing your source PM, but now I am even more bullish on Gold, if that's possible!
I am still bullish as well, but I wanted to put this info out there so there was a balance in perspectives...
Hey PM...did ya read my thingy here:
http://www.zerohedge.com/article/gold-whats-next-0
man thats good shit Gekko.
Yes I did ,great stuff
Appreciate the warning PM. In times euphoric times like this it is probably the most important to keep a level head. To paraphrase the great Alan Greenspan: I stand ready with a truckload of cash, should the price fall.
The buying pressure today emanated from London...As soon as London closed, price settled back...
I like your article and do like the work of Fekete. The only problem I see is that there your "signs" of impending financial dislocation are still nothing more than hunches. What the breaking point is is anyones guess. I don't fault you for this viewpoint. Isn't guessing a large part of speculation?
I think there is also no such thing as a New York spot market. It is derived from the present month future contract. A true spot price is still determined by the gold fix.
Thanks; you are correct. The following article is a good characterization of the various gold prices.
London fix. The five members of the London Gold Pool confer twice daily to determine the a.m. and p.m. price for gold. These are big players, so the fixings they announce have a quasi-official ring to them. But the London fixings determine the price only for trades that by pre-agreement are tied to the fixings. And each fixing has significance only at the instant it's made. Trading between fixings runs on its own, independently of the preceding fix.
Comex spot contract price. The Comex is the busiest market for trading futures contracts in gold bullion. Each contract is for 100 ounces. Prices during the day represent actual trades taking place in a continuous, competitive auction. When, through the passage of time, a given contract reaches its delivery month, it becomes known as the "spot contract." At that point, the party on the long side of the contact is free to pay for the physical and demand delivery, and the party on the short side of the contract is free to deliver the gold and demand payment. The possibility of insisting on physical delivery keeps the price on the spot contract tightly linked to the price on large transactions of physical gold between dealers.
New York dealer prices. If you visit www.kitco.com, you'll find quotes, updated every 30 seconds, for the "New York Spot Price." These reflect the bid and ask prices quoted by wholesale dealers for spot delivery. Not surprisingly, during Comex trading hours, they track the Comex price for the spot contract.
Will the Real Price of Gold Please Stand Up?
http://www.safehaven.com/article-14391.htm
Look at the GOFO versus the libor. No wonder libor is so useless. It's libor-gofo that matters?
Libor's the whore. GOFO is the room rent costs for the whore that work in it.
http://www.lbma.org.uk/?area=stats&page=gofo/2009gofo
I may be way off base. But londons paper currency looks something like an gold carry trade.
PM, imminent systemic crisis - although helpful - is not a necessary condition for Gold price to rocket. In fact, even a $2k price would just be equaling 1980's high and not represent a meltdown of the global financial system, so chillax, don't worry and just buy Gold.
In fact I think it's great that we are not in backwardation yet which means that we have a lot higher to run before "the system" blows up - which means we still have time to convert our paper profits from various markets into Gold.
BTW, only permanent backwardation would mean a collapse of the world financial system as it means that gold will not be dishoarded at any paper price. As long as we are able to switch from backwardation to contango with a rising Gold price, there is no problem as it means that there are Gold holders willing to dishoard at some higher fiat money price level.
So, can someone break this down more. This article assumes the reader knows what backwardation means.
I agree. There is plenty of available energy in the charts to carry gold into the 1400 range by year end.
Does permanent backwardation happen before or after the system implodes??
Right before. BTW, a system implosion would mean that there would be no futures market left for the backwardation to happen, so it cannot really happen after.
Here you could argue what implosion is. Bond/equity markets tank -> rush into metals -> ETF holders (gld, slv) get nervous -> run on physical metal -> backwardation.
There are just so many possible combinations of events that will lead to the end game. It's all speculation at this point, but the discussion itself is an important one to have.
I think backwardation will begin in silver anyways, jmo. Central banks have 0 supply to contain that market.
I would still suspect that they have derivatives that they can use to contain the price. In fact, I would guess that derivative are their primary method to supress gold as well.
Derivatives do not replace physical delivery.
Great question! We don't know ! I suspect before, based on past moves, but if gold does not go into backwardation until after things implode , then the signal is more or less useless, lol...
Anyway I agree, gold could easily continue to vault upward, I just want to point out that it is not in backwardation -- in fact , the opposite. The gold carry is increasing further into contango. Draw from this what you will, some of this is more of an art than a science... I just wanted people to be aware of the nature and state of the gold basis.
Someone please correct me if im wrong. But it's my understanding that as contango increases it eventually reaches a tipping point and "morphs" into backwardation.
It went into 48 hours of backwardation during December of 2008.
I'm trying to find the contago affect as it approached that date.
Think of this way. As you increase contango you draw gold from more and more sources. Think back to civil war. The unfunded war created a huge silver contango and the market literally got resupplied by people selling off thier silverware and silver jewelry etc.
We are in a huge contango market right now as we speak even if the crimex futures market won't print it. Wall to wall cash for gold commercials ARE golds huge contango. The economic downturn is nothing more than creating the necessary economic pain to make this hidden contango function. The more commercials you see will likely be the ONLY working sign of the conversion from contango to backwardation that crimex will NEVER print for you.
The seasonal demands for gold by india etc coupled with the suppression of contango signals for a prolonged "draining" and the longer it goes until people figure it out and start buying up gold at way above spot will be the speculative drive to crash the gold market into permanent backwardation.
increasing contango does not morph into backwardation....
every buy / sell and supply / demand relationship
has some kind of feedback mechanism which tends
toward some form of equilibrium (although i don't
really buy equilibrium analysis as a linear
phenomenon or as commonly taught).....
but there is nothing which says that increasing
contango must lead to backwardation....in fact
gold had been in perpetual contango between 1975
and december 2008....
over that period, however, the basis had been
steadily shrinking indicating declining interest
rates and that implies backwardation....
healthy stable interest rates are required for
capital formation....take away an honest return
and capital goes into hiding...that is the meaning
of backwardation...once that happens economic
activity grinds to a halt and economic decline
sets in....
usually this is precipitated by currency debasement.....
Well any commodity with spoilage or storage costs will have contango. The thing is the amount of contago is like the valve for sucking more commodity in. If gold goes up 80 bucks in Dec I guarantee you you'll see miners doing extra shifts and producing a bit more gold. My guess is that the contango relationship is based on production cycle timelines shipping consraints etc.
Backwardation on gasoline would indicate a huge glut and signal refineries to shut down.
Backwardation on gold though signals hording. That people don't want to supply the market.
It could also signal industry breakage. Like if Dec price on pork fell so low that it was unproducable at that amount then people would opt to pass on them and keep the pigs alive a few more months.
At least that's how I understand it to work.
Contango must match the inflationary tracts of a fractional reserve economy. It wouldn't be a normal part of a non fractional reserve economy.
a non fractional reserve system says nothing about
the basis of gold....two totally different concepts....
gold constricts money supply in a fractional reserve
banking system...and it can exist with or without
a futures market....
the gold futures market was introduced to keep the
fiat system from collapsing....fiat MUST have gold -
which is why it was introduced in 1975...before that
time it was never needed because gold circulate
freely....
the production of gold in respect to the basis
is not modeled after other commodities because the
large large bulk of gold is already above ground
and always will be (that's not an easy thought and
is actually a taunt rather than a precise statement
of fact)...
i agree that if the gold price is too low production
will decline or cease as we have seen over the
past 8-9 years....but that is not so much a production
issue as a pricing issue...but even if we had production
issues the above ground supply of gold would serve
the needs of money...
According to Rob Kirby (Kirby Analytics) the dealers are offering cash premiums to settle contracts with fiat rather than metal. So there may be an implied backwardation going on under the radar. Time will tell.
PM,
Would also note that trying to buy physical gold any where close to the spot price is a pipe dream. Currently we are getting premiums of $27 over spot from my distirubtor. So clearly, the cash price of buying an ounce of physical gold has moved well above the futures.
Have you taken this into account?
PM, in your opinion, what is the best way to buy physical gold offshore?
Try:
http://www.bullionvault.com
I've been with them for two years, costs are low, I doubt you'll find better.
Thanks for your excellent work PM.