Turk: “The big news here in London, Eric, is that gold
slipped into backwardation once again. The previous backwardation ended here in
London on Monday, when the US was closed for a holiday. It looked like a
concerted effort by the central planners to put gold and dollar interest rates
back into their normal relationship...
“But this artificial condition
could not hold because the demand for physical metal is just too strong. So
gold's 1-month forward rate against the dollar is once again negative.
I think some history will be
useful to help explain what is happening, starting first with what took place in
1999. In May of that year, British Chancellor Gordon Brown announced that
Britain would sell one-half of its gold reserves. That announcement started a
selling panic which ended with the so-called ‘Brown bottom’ on July 19 at $253.
In a couple of months, gold had dropped about 10%.
As we now know, that selling
climax ended the 19-year bear market in gold. Importantly, the gold price then
began to slowly climb. At the end of September 1999, central banks announced
the Washington Agreement on Gold which limited the weight of gold they would
lend to the bullion banks that had been actively borrowing metal.
This activity was a major reason
why the gold price had fallen nearly 40% over the last years of the 1990s. So
it is understandable that the central bank announcement resulted in a big $30
jump in the gold price to over $300, and for a couple of days, gold even went
into backwardation -- indicating a shortage of physical metal. Thereafter, the
gold price began what has become a historic multi-year climb.
Now, let's fast forward to 2008.
After the Lehman collapse there was a rush for liquidity, and gold is one of the
most liquid assets. So it was aggressively sold into November of 2008, when the
selling pressure ended as gold went into backwardation for a couple of days.
And as proof that the baby was thrown out with the bath water, gold climbed from
$717, at its November 2008 low, to $1,000 by February 2009. And it kept
climbing for two more years.
During each of those two previous
periods, gold was in backwardation for just a few days. In contrast, the
backwardation that ended Monday prevailed for a totally unprecedented and record
breaking 40 trading days. During that time, gold rose from $1,200 to over
$1,430. It was a spectacular jump in price. But with gold again below $1,400,
the backwardation has re-appeared.
Where are the arbitrageurs? Why
haven't they stepped in to take the easy profits? All they have to do, Eric, is
sell their physical metal and simultaneously buy it back for future delivery at
a cheaper price. Plus, they have use of the proceeds from their sale to
invest. They also avoid storage costs while they own paper gold - a promise to
pay gold in the future - instead of physical metal. For the big gold players it
is easy money laying right there on the table, in plain sight for everyone to
see. So why don't the big players take the advantage of the arbitrage?
Is it because they fear the
promise to deliver physical gold to them in the future will be broken? Do they
value a tangible asset more highly than a financial asset? Do they believe the
reward for holding physical metal is greater than the potential of a short-term
profit?
We of course do not know the
answer to these questions, but one thing is clear, this new backwardation
illustrates that physical metal remains scarce, or in other words, it is being
held in strong hands. It is therefore going take much higher gold prices to
entice these strong hands to part with their metal and instead hold some
depreciating national currency.
Most importantly, Eric, if we
look at what happened with regards to the persistent rise in the gold price
after gold became backwardated in 1999 and again in 2008, we can only conclude
from these precedents that gold has much further to rise in the weeks and months
ahead.”
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