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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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+1000 Great work, makes this site roll
Thanks for the clarification.
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