Backwardation

In this part, we discuss stocks vs. flows, how prices are formed in a market, a broad concept of arbitrage, spreads, and how money comes into and goes out of existence.

"The “coordinated smashdown of gold and silver” was on everyone’s mind this week, but is it true? Did the price of paper gold divorce from physical? Let's look at the data.

Gold and silver crashed. Here is a sometimes-humorous and often-irreverent and hard-hitting discussion. This is a different perspective and we hope to expand your thinking about gold and silver.

I asked the question: is Bitcoin money? (It's price sure is rising parabolically like silver in 2011) In brief, I said no it’s an irredeemable currency.  This generated some controversy in the Bitcoin community.  I took it for granted that everyone would agree that money had to be a tangible good, but it turns out that requirement is not obvious.  This prompted me to write further about these concepts.

Do you think that depositors in Cyprus are being taxed? That their money is being taken from them to go to the government in Cyprus or to Europe? Most analysis of the Cyprus bailout is wrong...

This is the third and last of three articles we are posting on the price suppression of gold. In the first article we showed that, under mainstream economic theory, the suppression of the gold market is not a conspiracy theory, but a logical necessity, a logical outcome.  Mainstream economics, framed by the Walras’ Law, believes in global monetary coordination which, to be achieved, necessitates that gold, if considered money, be oversupplied. The second article showed, at a very high (not exhaustive) level, how that suppression takes place and how to hedge it (if my thesis is correct, of course). Today’s article will examine the systemic impact of this suppression and test the claim of the gold bugs, namely that physical gold will trade at a premium over fiat/paper gold, commensurate with the credit multiplier created by the bullion banks. (Hint - it is)

Backwardation is when there is a (seemingly) risk-free profit to decarry the metal. It is fascinating that it persists. It’s been there for weeks! Does no one have gold to put towards this trade?

We noted the strange divergence between the surge in physical demand for precious metals and the falling price of gold and silver yesterday and today; sure enough, just as they give back some short-term gains, we find that with one day left in the month, the US Mint has seen the largest demand for physical silver coins ever for a February at 3.37mm ounces. We are sure this all makes perfect sense somewhere in the leasing, backwardation, securitization, paper world of precious metals pricing but one thing appears sure, more than just Russia is backing up the truck for physical bullion.

Traders read the headlines. They know how the price “should” react to news, and they begin buying. For a while, the prophecy fulfills itself. But then what happens next? It may take an hour or a month, but sooner or later some of the new buyers begin to sell.

Speculators can drive the price quite far in either direction, in the short term. But it is the hoarders and arbitrageurs who drive the price in the long term.

In part one of our series we discussed stock to flow dynamics and their impact on the gold price. In part two of our series we discussed how 'paper gold' - meaning ETF’s, futures and various derivatives - simulate flow where none actually exists. In the final segment of this series we want to explore an important signal that could identify the demise of paper gold and/or signal a loss of confidence in the US Dollar and cause an abrupt increase in the stock-to-flow ratio and the physical gold price. Of the several periods of backwardation in the gold market, two of the most interesting and significant followed the September, 1999 Central Bank “Washington Agreement” on Gold and more recently during the dark days of the 2008 financial crisis. In both instances we believe the primary force causing gold backwardation was near catastrophic collapse in counterparty viability.

Since late January, the February gold contract has been in backwardation.  But today something more serious occurred .

We have gone from a supply and demand market to a funds flow market and this really sucks for consumers. 

Presenting Dave Collum's now ubiquitous and all-encompassing annual review of markets and much, much more. From Baptists, Bankers, and Bootleggers to Capitalism, Corporate Debt, Government Corruption, and the Constitution, Dave provides a one-stop-shop summary of everything relevant this year (and how it will affect next year and beyond).

Overnight the Shanghai Composite index rose 4.3%, marking its biggest advance since October 2009, supported by the latest HSBC flash manufacturing PMI which came in at 50.9 vs Exp. 50.8 (Prev. 50.5) – 14-month high, and with hopes for supportive policy direction to come out of this weekends central economic work conference where Chinese leaders will look to set next years GDP target and layout more information on policy for urbanisation. As such WTI crude has been trending higher since the Asia session testing around the USD 87.00 to the upside with close to a 1 USD gains ahead of the NYMEX pit open. In terms of Europe, bund volumes have been light as markets head closer toward the Christmas break with European manufacturing and service PMI’s having little sustained impact with Italian and Spanish 10yr government bond yield spreads over German bunds seen 2.5bps and 3.5bps tighter respectively. Elsewhere, in the FX market there has been talk of US names selling 1 week 25 delta risk reversals in positioning ahead of this weekend’s Japanese elections.

1. Stay short AUD/NOK, opened at 5.90 on 03 Dec 2012, with a target of 5.00 and a stop on a close above 6.35, currently at 5.88.
2. Stay long risk (sell protection) on the CDX High Yield on-the-run index, opened at 506bp on 04 Dec 2012, with a spread target of 450 and a stop on a close above 550, currently at 516.
3. Go long the Commodity Carry Basket (Crude, Corn and Base), opened at 100 on 05 Dec 2012, with a target of 112 and a stop on a close below 94, currently at 100.