Turk - Something Shocking Has Occurred In The Gold Market

"...This brings me to the second key event taking place:  Even the LBMA website now shows that gold is in backwardation.  The gold forward rate out to three months is negative.

The LBMA stopped reporting silver forwards last year because they were artificial.  They showed silver in contango, but you could not deal at those rates.  The obvious implication is that silver was actually in backwardation.  The point is that silver, and particularly gold, are not supposed to go into backwardation, at least in theory.  That's because they have huge aboveground stocks, in contrast to other commodities that have limited aboveground stocks.

Look at the current backwardation in crude oil for example.  The August 2013 contract is $10.47 higher than August 2014.  So if you have physical crude in hand, you sell it today and immediately buy the Aug-14 contract, earning not only the $10.47 per barrel price difference but you also have the use of the $103.22 you receive as the proceeds from your sale.  To top it off, you avoid storage charges for one year.  So clearly, there is a shortage of crude oil.

Backwardations in oil can occur because its supply is limited.  Its aboveground stock is counted in days of use, in contrast to gold where the aboveground stock is essentially all of the gold mined throughout history.  So when backwardation occurs in gold, it is an earthshaking event.  People who own physical metal do not want to profit from the backwardation, even though they are only taking a credit risk for as short as one month.  They want to own physical metal, regardless of the potential profit, because earning this potential profit depends on the ability of the entity selling the future contract to deliver physical metal to you when the contract comes due. 

 

Gold backwardation is occurring because the big bullion dealers, hedge funds and arbitragers, do not want to take this risk.  This phenomenon highlights the difference between physical metal and all of its paper substitutes.  When backwardation in the metals occurs, it means two things:  First, people want physical metal and not paper promises to deliver metal in the future. 

Second, it means that the physical market is starting to drive the price of the metal, rather than what we have seen the past several months where paper selling drove gold and silver prices to abnormally low levels.  The bottom line, Eric, is that in a year or two when we look back at today, we will marvel at how cheap the prices of physical gold and physical silver plummeted to.”

 

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