Guest Post: Temporary Backwardation: The Path Forward From 2008

Tyler Durden's picture


Submitted by Keith Weiner of Keith Weiner's Posterous blog,

The March silver futures contract first entered backwardation on Mar 9 and with a few zigs and zags has not only remained there but has gone deeper and deeper in. The April gold future just entered backwardation today. See the graph below (backwardation is when (Spot(bid) - Future(offer) > 0).


We shall see what the coming days bring for the April gold future, but the fact that backwardation has occurred at all is significant. The fact that it is now a “normal” occurrence since fall 2008 indicates a deep pathology.

I have written in the past about gold and silver backwardation ( and and The gist is that one can look at the spread between the price of a future vs. the price in the spot market of the same commodity.

We define the basis as the Future(bid) – Spot(ask) and the cobasis is, as mentioned above, Spot(bid) – Future(offer). In a normal world, the basis is positive and it is basically given by the rate of interest. The cobasis should be negative unless there is a shortage. A shortage of gold or silver is meaningless as people have accumulated enormous inventories of the stuff over thousands of years.

But in the “new normal”, post 2008, the expiring gold or silver future often flirts with or even slips into backwardation for a period before expiry. This is anything but normal. It’s not a sign of imminent financial Armageddon, but it is a sign that beneath the surface there is a growing rot in the core of the system. Why?

The short answer is that no actionable opportunity to make free money should last more than a millisecond (or less, due to High Frequency Trading). If one can see a “risk free profit” sitting on the screen day after day, let alone if this profit is growing, this is a sign that All Is Not Well even if one doesn’t know why or what specifically is happening. Backwardation means that anyone who has gold or silver could simultaneously sell the metal and buy futures contracts to recover their position, and make a profit. And, given the enormous stocks of gold and silver, many people have lots of gold and silver.

The backwardations that are “normal” today are too small for the retail trader to profit from, given that he must pay commissions. But they are easily large enough for many institutions that make a market in gold (especially compared to their alternatives for short-term capital). The following question remains unanswered:

Why do institutions not take the risk-free profit offered to them in gold and silver?

I don’t believe it’s because they are afraid of the risk. I make this statement in light of two facts: (1) the near-month future expires very soon (about 5 weeks for April gold or a week for March silver) and (2) the farther-out futures are not in backwardation. The financial system is not going to collapse in 5 weeks, and if it were then the farther futures would fall further into backwardation. Trust in delivery 5 months from now would be less than trust in delivery 5 weeks or 5 days from now.

As a reminder, to profit from contango, one must buy physical and sell a future against it to end with the same net position plus a small profit. To profit from contango, one carries the metal. Think of carrying as like warehousing it for a small fee. The only prerequisite is that one needs cash (or more typically credit). Carrying will push up the ask in physical and push down the bid in the future, thus reducing the basis.

In contrast, to profit from backwardation, one decarries by selling physical and buying a future. The prerequisite is that one needs the metal. One could either sell one’s own metal, or if one had previously carried metal one could unwind the carry. Either way, this would push down on the spot bid and up on the future ask until the cobasis was zero or negative.

For whatever reason(s), this is either not occurring or despite it, the ask on the future is falling relative to the bid on spot.

For now, let’s just say that the market is tight. The metal is out there, but obviously those who have it in an unencumbered form are not able (retail) or willing (others?) to take this backwardation bait.

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Thu, 03/22/2012 - 12:33 | 2280682 Badabing
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Thu, 03/22/2012 - 12:41 | 2280698 A Nanny Moose
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Thu, 03/22/2012 - 12:46 | 2280719 Sophist Economicus
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Thu, 03/22/2012 - 12:51 | 2280738 Manthong
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"Backwardation means that anyone who has gold or silver could simultaneously sell the metal and buy futures contracts to recover their position, and make a profit. "

Um... MF Global.. CAC.. GM Bonds.. JPM silvir short positions..

Does counter-party risk, solvency, confidence in the trustworthiness or fiduciary responsibility of the government or banks play any part in this trade?

Thu, 03/22/2012 - 12:51 | 2280747 johnQpublic
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sell the present

buy the future

rent the past?

Thu, 03/22/2012 - 13:12 | 2280849 Ahmeexnal
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the coastline is receding, thus enabling the casual observer to find out who was swimming naked. however, those in the know prefer to run to the hills, as experience dictates a tsunami will soon follow.

Thu, 03/22/2012 - 13:33 | 2280962 DoChenRollingBearing
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Yes!  Buffet, correct?

We will soon see who the jerks are.  We may soon see a tsunami...

Thu, 03/22/2012 - 12:51 | 2280748 Sophist Economicus
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That's the point!

Thu, 03/22/2012 - 12:58 | 2280795 SheepDog-One
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50X leveraged to boot!

Thu, 03/22/2012 - 13:59 | 2281084 Ratscam
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Brent oil Dez. 13 is USD 12 in backwardation!
Free storage and interest!

Thu, 03/22/2012 - 23:01 | 2282493 StychoKiller
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In contrast, to profit from backwardation, one decarries by selling physical and buying a future.  The prerequisite is that one needs the metal.  One could either sell one’s own metal, or if one had previously carried metal one could unwind the carry.  Either way, this would push down on the spot bid and up on the future ask until the cobasis was zero or negative.


Check out the sentence I highlighted -- "They" don't gots the metal!

Thu, 03/22/2012 - 13:07 | 2280831 F22
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Thu, 03/22/2012 - 12:45 | 2280717 tocointhephrase
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and then some!

Thu, 03/22/2012 - 13:10 | 2280844 exi1ed0ne
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Thu, 03/22/2012 - 13:11 | 2280845 exi1ed0ne
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Fri, 03/23/2012 - 09:24 | 2283088 Imminent Crucible
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"Why do institutions not take the risk-free profit offered to them in gold and silver?"

That's a remarkably ignorant/dense question from someone who opines on commodity futures markets. The answer is simple: It's NOT risk-free, and there are NO "enormous stocks" of silver on hand. The signs of shortage are everywhere.

You risk selling your physical silver only to find that when delivery day arrives, you don't get your silver back at a cheaper price. Instead, you get a cash settlement. Comex is forcing cash settlements all the time now. There is strong evidence that even GLD and SLV are being settled in cash.

Right now, the silver chart is carving out the right shoulder of a multi-month inverted H&S pattern. The right shoulder low should develop over the next few sessions near $30. After that, get out the way.

Thu, 03/22/2012 - 12:41 | 2280702 SHEEPFUKKER

More bankster dumbfuckery. 

Thu, 03/22/2012 - 12:44 | 2280713 Schmuck Raker
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" to profit from backwardation, one decarries by selling physical and buying a future."

No one willing to take their eyes off their gold sounds like "Smartfuckery" to me.

Thu, 03/22/2012 - 12:51 | 2280743 SheepDog-One
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Sell your gold to us, and buy a FUTURE instead! Its really a good deal, we promise!

Signed- Trickfuckery FED

Thu, 03/22/2012 - 13:05 | 2280820 Alea Iactaest
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Right. But why buy a BUNCH of gold right now and then promise to sell it back later? What would someone do with a BUNCH of gold right now? Is this connected to the recent sell-off in PMs? Getting a bunch of gold now could let someone meet delivery, possibly due to a short position. Maybe the guy standing for delivery can't be bought off, like what's-his-name in Venezuela.


Might be possible to dry up some unencumbered gold supply to make things more difficult for anyone trying to set up an alternate (e.g., non-USD) payment system or operating outside the SWIFT system. Not that I can think of any countries fit that description at the moment.


On a related topic, why is Turkey trying to get more gold into its banks right now?

Thu, 03/22/2012 - 13:05 | 2280821 1100-TACTICAL-12
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"dumbfuckery" indeed.

Thu, 03/22/2012 - 13:16 | 2280861 Lmo Mutton
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+1 for the flag and the 1100WIN

Thu, 03/22/2012 - 12:41 | 2280704 blunderdog
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Gold backwardation?  Head for the hills!

Thu, 03/22/2012 - 12:42 | 2280706 DoChenRollingBearing
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If gold stays in backwardation for more than a few days, it may be over, bitchez!

(source, but not his words: Fekete)

Thu, 03/22/2012 - 12:42 | 2280708 Zero Debt
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Refresher on Gold Backwardation from FOFOA:


Thu, 03/22/2012 - 12:54 | 2280769 DoChenRollingBearing
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+ $55,000

Off to read the link now.

Thu, 03/22/2012 - 12:43 | 2280709 Sophist Economicus
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I have a weekly buy program for gold bullion coins (trigger just gets pulled, regardless of price - stops me from out-smarting myself).   Money is wired, so there are no postal delays.    Delivery has been getting longer, the 2012 Eagles have stopped coming and I'm getting the Roman date series now.


Might just be coincidence.   Now, Tulving always has what I want, but they are bulk players.   


Didin't really run into this issue last year.   SOmething may be up.   I'm all for these dopes driving the price down, but I hope they know what game they're playing....



Thu, 03/22/2012 - 14:05 | 2281127 XitSam
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Similar experience but in silver.

Thu, 03/22/2012 - 12:45 | 2280714 EL INDIO
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Gold is below the 200 DMA, now is the time to accumulate. This is a no brainer.

Nowadays information cannot be trusted, too many lies, too much disinformation, too much speculation, too many assumptions too much bias.

Don’t let the tree mask the forest from your view.

Thu, 03/22/2012 - 12:46 | 2280720 RoadKill
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Guys - hold PAT.  I will tell you when it is time to buy with both fists.  Hell when gold < SPX I will buy with leverage - but not yet.  HOLD!!!  HOLD!!!  Wait till you see the whites of their eyes..

Thu, 03/22/2012 - 12:48 | 2280729 Sophist Economicus
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Who is Pat?   I hope it's short for Patricia...

Thu, 03/22/2012 - 14:10 | 2281154 oddjob
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That's his last name. First and initial is Stan D.

Fri, 03/23/2012 - 01:09 | 2282673 MeelionDollerBogus
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If you're concerned about not getting the best deal on a future dip that's very very near then buy gld PUTs or edge into the purchase in 2 or 3 stages (keeping in mind the premiums paid, shipping, whatever, each time). Gold's insurance goes beyond short-term paper price you can get if you want to unload it. In fact if you want paper profits so badly then just get a GLD strangle & forget about bullion. Just remember that if paper vaporizes & counter-party risk is MF Globalled you'll be left with NOTHING.

Thu, 03/22/2012 - 12:46 | 2280723 Zola
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MF global...

Thu, 03/22/2012 - 12:48 | 2280732 SheepDog-One
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Its just a barbaric relic anyway, except to the worlds banks who continue to hoard gold and try to get it from private hands into govt hands like Turkey, for whatever barbaric reason.

Thu, 03/22/2012 - 12:54 | 2280765 mark mchugh
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Soon to be deposed dictators always try to abscond their crumbling nations with it too, for whatever barbaric reasons.

Thu, 03/22/2012 - 12:57 | 2280789 SheepDog-One
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I know, its so heavy and cumbersome and all....and like Buffet says gold is just dug up in one place, only to be re-buried in someones back yard anyway..such barbarism. 

Thu, 03/22/2012 - 13:13 | 2280854 Vince Clortho
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I take it this "Buffet" you speak of is some kind of Seer?

Thu, 03/22/2012 - 12:49 | 2280734 mark mchugh
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"A shortage of gold or silver is meaningless as people have accumulated enormous inventories of the stuff over thousands of years."

Ummmm there are no enormous inventories of silver anymore, unless you consider a less-than 1year supply enormous.  The only problem with precious metal prices is for every person taking physical delivery, there's a hundred nimrods willing to bet on the price action.  So the object of "price action" becomes to seperate as many of said nimrods as possible from their fiat.

Shark boy and Lava girl understand this, maybe you should too.

Fri, 03/23/2012 - 03:24 | 2282756 UnpatrioticHoarder
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Prof Fekete speculates that China may have a large silver hoard against which they sell options to earn an income.

Thu, 03/22/2012 - 12:52 | 2280754 carbonmutant
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Metal vs. paper....

Thu, 03/22/2012 - 12:54 | 2280764 johnQpublic
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bought eleven silver eagles off guy on craigslist yesterday for 300 dollars

but i lost 'em when my kayak sank

Thu, 03/22/2012 - 13:21 | 2280888 ParkAveFlasher
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I traded mine to a 70-year-old Turkish hooker for a gumjob.  And let me tell you, she didn't wait long for me to mature - OHHHH

Thu, 03/22/2012 - 16:43 | 2281775 Likstane
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I'm sorry dude. Tough way to lose your stash.  My shitty green Coleman 12 footer couldn't muster it when a rogue wave took me down off Washington's coast real close to where the ferry leaves out of Edmunds. 

Fri, 03/23/2012 - 09:12 | 2283050 Vlad Tepid
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You haven't been around much have you?  We ZHers PMers take LOTS of over water trips in small craft and we aren't very skilled at watercraft.  Hell, we've tipped in so many lakes and oceans that we don't even remember their names.

Thu, 03/22/2012 - 12:54 | 2280768 SheepDog-One
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'Sell your physical, and buy some of these here paper future bet markers instead'!

Uh, thanks but no thanks.

Thu, 03/22/2012 - 12:59 | 2280798 Bam_Man
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Lots of people holding (the same, re-hypothecated) "paper" gold.

More and more physical is going into hiding. Why wouldn't it after the MF Global fiasco?

I'm surprised the backwardation isn't even more severe.

Thu, 03/22/2012 - 13:01 | 2280807 LawsofPhysics
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"Why do institutions not take the risk-free profit offered to them in gold and silver?"

What?  Wake the fuck up, many institutions have, in fact, been taking physical delivery.  Paper is otherwise irrelevant.

Thu, 03/22/2012 - 13:17 | 2280865 sitenine
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'risk free' - yeah, that's a good one. Apparently, the author missed that little MF Global incident.

Thu, 03/22/2012 - 16:06 | 2281620 mick_richfield
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No, you don't understand.

By "risk free" he did not mean "no risk".

He meant "you get the risk without paying extra for it."

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