Backwardation, the Bank of England, and Falling Prices

In commodity markets backwardation is an indicator of physical shortages. Shortages result in buyers bidding up the cash price of the commodity above the future prices. This creates a profitable trade (called decarry) for those holding the physical commodity – they can sell it now and buy a futures contract at a lower price, locking in a profit.

Backwardation should therefore be associated with rising prices. However, in a recent Macro Voice podcast, guest Jeffrey Snider noted the anomalous situation in the gold market between 2013 and 2016 where negative gold forward rates (GOFO) indicated backwardation while the gold price was falling. Jeffery’s chart below shows periods where the LBMA GOFO rate was below zero, along with the Bank of England’s custody holdings (gold held on behalf of central banks and bullion banks).

Jeffery sees this unusual situation being related to the Eurodollar market:

“Whenever I see the forward rate go negative, and we see gold disappear from official stores, that tells us that there is a funding problem, a collateral problem, in these global Eurodollar markets.”

Unfortunately, Jeffery’s chart stops at January 2015, as the LBMA discontinued publishing GOFO due to increasing regulatory costs associated with operating a benchmark. Fortunately, Monetary Metals has developed MM GOFO™, a market-derived replacement rate with a very high correlation to the historical LBMA GOFO.

The chart below shows the Bank of England holdings along with the gold held by the US ETF GLD against the times the MM GOFO 3m rate is below zero.

The first time MM GOFO goes negative is April 12, 2013 and again on the 23rd but it is not until mid-May that the rate moves into solid negative territory. It is as this point that a significant amount of gold at the Bank of England starts to be withdrawn. When MM GOFO returns to positive in mid-2014, the Bank of England holdings stabilize but then fall again once MM GOFO drops below zero for the second time.

It is only after MM GOFO rises and stays above zero that gold returns back to the Bank of England. Similar behavior is also exhibited with the holdings of GLD, including the pause in mid-2014. Over the three year period approximately 1,600 tonnes were withdrawn from the Bank of England and 650 tonnes from GLD.

Where did all that metal go? For the three year 2013 to 2015 the UK net exported 2,385 tonnes, with the largest recipient being Switzerland for re-refining and eventual shipment to Asia.

This period is of particular interest to gold investors because it was in April 2013 that the gold price broke support levels and crashed from the $1600s to below $1300, all the while there was booming demand from Asia. The chart below shows this time period, comparing the gold price to MM GOFO. It cannot be coincidental that MM GOFO first moved below zero, and Bank of England withdrawals picked up speed, in April as well.

In hindsight, both the gold price and MM GOFO had their last peak in October 2012 before rolling over with GLD and Bank of England holdings peaking later in December 2012 and February 2013, respectively.

While we do not discount the impact of the Eurodollar funding/collateral issues Jeffery identifies, we consider the fact that forward rates were falling along with the price as indicative of another dynamic in play. Regular readers may get a hint when we note that forward rates are another way of looking at a topic we discuss every week in our Supply and Demand reports – the basis and cobasis.

For a forward rate (or basis) to fall, it means that the difference between futures prices and spot prices must be getting smaller. In commodity markets, this manifests as the spot price being bid up faster than the rate at which futures prices are also rising, closing the gap to futures. Eventually spot moves above futures, resulting in backwardation.

However, in the case of gold, the fact that the stock of gold above ground is equal to over 60 years’ worth of mine production means that gold is not a typical commodity and cannot really ever be in shortage.

In the case of 2013, the falling forward (basis) rate indicated that it was futures prices which were falling faster than spot, closing the gap, until futures fell below spot, giving us negative MM GOFO. The driver for this behavior is the leverage inherent in futures contracts: futures traders are under more pressure to liquidate positions once they move against them, than those holding fully paid physical (spot) gold.

As we see in the chart above, while forward rates were positive they were in a falling trend from late 2012 onwards. Positive forward rates mean it is profitable to carry gold – buying physical gold at spot, storing (or carrying it) and selling a futures contract against it at a higher price – but this profit was declining into early 2013.

Once rates moved below zero in April 2013, the market moved into a situation where decarry became profitable. Thus bullion banks with physical gold at the Bank of England were incentivized to sell that gold in the spot market and buy it back at a lower price, via futures or forward purchases (from a mining company, for example).

This decarry pressure remained until early 2016 when the gold market bottomed and forward rates began to rise on the back of resurgent dollar interest rates, shifting the market back to the more normal contango state where the incentive was to carry gold. It is no surprise that stocks of gold held at the Bank of England recovered at this time, increasing by 600 tonnes.


Bron Suchecki

© 2018 Monetary Metals


El Oregonian MrBoompi Wed, 03/28/2018 - 13:17 Permalink

Gold is viewed as nothing more than a junkyard dog to me. Feed it daily- pretty much neglected- overlooked pretty much of the time...

But boy, piss it off, or try and sneak past it, and it will be all over you like an angry bitch-slapped forgotten whore! And she will make you pay you bastards!

This is why it is not to be associated with pleasant company, but rather hidden away from civil eyes and made to toil completely in the sanctity of it's own darkness.

In reply to by MrBoompi

philipat El Oregonian Wed, 03/28/2018 - 20:40 Permalink

Weiner, Sucheki and Christian are amongst a small and declining group who will never admit that Gold is being manipulated because they all have different vested interests.

There is a simpler explanation than the convoluted theory in this article as to what was going on: there was enormous physical demand coming from China which could only be met from Western inventory draw downs whilst the physical Gold price was prevented from rising (a/k/a manipulated lower) using the futures "markets" because paper Gold naked short contracts can be printed almost to infinity with only a very small physical backing. The paper futures "markets" are the "price discovery" for physical spot Gold.

And this scam continues unchallenged by the "Regulator" because it is The Fed/CB/ESF/BB Complex behind it. But the Comex is running out of physical metal and so now must ship delivery obligations off to London via EFP Contracts. BUT these amount cumulatively to thousands of tons of metal over the last 2 years and there is no way that London can actually deliver so much metal. So precisely WHAT is happening to those ESF obligations in the totally opaque London "markets"? I would contend that London is simply where all the Comex delivery obligations, via EFP contracts, go to disappear only to reappear as new naked short Comex paper contracts. This is all part of the same paper game that CB's use to manipulate the PM's down to just above the actual all-in cost of production.

In reply to by El Oregonian

Bron Suchecki philipat Thu, 03/29/2018 - 10:24 Permalink

Here's what I said back in 2013 I believe in manipulation but not suppression. One is short term, the other long term. Many of the manipulation and suppression theories are simplistic comic book stuff. Often why people consider me anti-manipulation is because I critique these theories. Doesn’t mean I don’t believe others, like this : “To kill gold you don't manipulate its price, you manipulate its volatility.”

As to your simpler explanation, that actually fits with what I said and the charts - the metal flowed out of BoE to Switzerland to Asia and that the futures price was falling faster than spot.

In reply to by philipat

Bron Suchecki PlayMoney Thu, 03/29/2018 - 10:39 Permalink

I was reporting what LBMA said, and regulatory costs were/are certainly a factor. But LBMA stopping the publication of GOFO doesn't mean that they can hide it, anyone with access to the data feeds from Thomson Reuters or Bloomberg would have been able to estimate it. What Monetary Metals has done is use those data sources to back calculate it and make the MM GOFO rate public so that anyone can check it out to see if it is screaming.

In reply to by PlayMoney

Bay of Pigs Seasmoke Wed, 03/28/2018 - 13:05 Permalink

Because if people really understood the situation with leases, swaps and encumbered physical stocks of gold, the whole sector would implode. The widespread fraud, manipulation and deception is central to fractional reserve lending in the gold market. Thus, the secrets are held tightly like nuclear launch codes.

The fucking stooge above, Bron Suchecki, has never addressed the paper scams when it comes to gold trading (futures, ETF's, swaps, leases, etc...). Keith Weiner isn't any better. 

Fact is, Monetary Metals is nothing but a disinformation outlet. 

In reply to by Seasmoke

Bron Suchecki Bay of Pigs Thu, 03/29/2018 - 10:34 Permalink

See my response above regarding manipulation, I have never denied it.


As to "really understanding the situation", I wrote a 14 part series "Fractional reserve bullion banking and gold bank runs" back in 2014 that explains the mechanics of the bullion banking system. You cannot find this information anywhere else. Here is a quote from post #12… in the series "Yesterday I finished with the statement that central bank lending of gold allows the bullion banking system to expand gold credit and this extra supply suppresses the price. I think a simple example may be useful." and I concluded that post with "To the extent that people are willing to hold this paper, be it futures or BB unallocated, then those longs facilitate and support the game. The question then is when (if?) will they "run""

I would consider those posts as "addressing the paper scams".

In reply to by Bay of Pigs

Grandad Grumps Wed, 03/28/2018 - 13:03 Permalink

If one thinks about it logically, backwardation does not make a lot of sense. Why should prices be lower in the future than they are now when supply is tight? Is there an automatic assumption that supply will be larger in the future and that will decrease spot price? I do not believe that is in fact the way it works ... but backwardation still exists and is great for locking in price and profits in a metal using industry.

Thautikus Wed, 03/28/2018 - 13:06 Permalink

"Thus bullion banks with physical gold at the Bank of England were incentivized to sell that gold in the spot market and buy it back at a lower price, via futures or forward purchases (from a mining company, for example)."

First, the author provides no proof whatsoever that that any physical gold actually moved anywhere, in other words they cannot provide proof of physical sale or change of ownership. In other words the Bullion Banks 'sold' it to a wholly owned subsidiary and then 'bought' it back on the cheap by manipulating the spot price and booked the profits. Prove me wrong.

Second, futures should only be available to actual registered producers to hedge risk based on actual production/yield and not used by Bullion Banks to manipulate spot prices based on selling non-existent physical into the 'market'.

But hey, that's just me.


ReturnOfDaMac Wed, 03/28/2018 - 16:29 Permalink

Disagree, the market should be left exactly the way it is.  If you are stupid enough to part with your booty for a paper promise in the future, and paper promise is accepted by poor slobs who actually toil in the ground and dig out real gold, then everybody gets what they deserve.  If people part with hard earned gold for peanuts, this is the very definition of a market!  Manipulated or not, if all parties agree, who are we to argue?

BobEore Wed, 03/28/2018 - 21:34 Permalink

Welcome to yet another pissing match

between pissed off bagholders... who failed to do their homework before declaring themselves special geniuses...

and the theorists who love to piss them off! Bron really could have reduced the text to the one salient point which matters here:

"However, in the case of gold, the fact that the stock of gold above ground is equal to over 60 years’ worth of mine production means that gold is not a typical commodity and cannot really ever be in shortage."

as all the rest is pure entertainment for the short pants set. Who unfailingly avoided getting the only memo which mattered...


and therefore achieved their 'peak potential'... as angry guys in search of a place to pin the blame... for their own hubris and insanity.

Pearson365 BobEore Thu, 03/29/2018 - 01:58 Permalink

You're back to that old stock vs flow argument which is certainly relevant however the gold market is nearly completely opaque with correct data in that area.  Therefore no one including you can claim what is actually going on with stock vs flow until you become a genius and provide that data accurately.  Neither monetary metals nor the WGC provide it anywhere near correctly since based on all the proven blatant lies they put out, they have been completely discredited.

Be the first one to help set the record straight and tell us how much shiny you own and where it's hidden.  Also tell us about how much you've bought and sold and when.

In reply to by BobEore

Thom Paine Thu, 03/29/2018 - 08:22 Permalink

"they" have been Superhuman in their ability to keep gold price under tight control.

I don't expect it to change until something systemic in the control system changes.