Gold and Silver Backwardation

Mon, Feb 25, 2013 - 12:12pm

I am not backing down from this and it is OK for otherwise agreeable people to disagree. No one has all the answers, regardless of their level of expertise and experience, and differing opinions are what make a market.

And I'm expecting a bottom here, too. The charts are looking better...which, admittedly when compared to last week, isn't saying much.

Let's start by revisiting DrC, crude and Sylvia. Ten days ago, they gave us clues that a period of "general commodity weakness" was coming. What are they saying now? Well, all three look poised for a rebound. Will they? And again, why is this important? Because buying interest in these 3 will almost always spark some spillover interest in the PMs, regardless of that day's Bullion Bank intentions or POSX movements.

Let's start with crude. Recall that I urged traders and even those with UCO to consider taking profits at $98. I expected a drop to $93 and we got it. So, now what? It would appear that the $95 level holds the key. Above there and the possibility exists for a jump back to the $98-100 level and a possible breakout. Below $95 and you have to guard against a drop toward $90, maybe even $88.

And what about copper? On the drop last week, it seemed everyone and their brother was mentioning how we all need to keep an eye on "DrC". That is, of course, true but I'm not here to sound any alarm least not yet. As you can see, after failing to hold the breakout that we were closely monitoring two weeks ago, copper has simply fallen back into the pennant which has contained it for over a year. Until and unless a sustained breakout occurs, it remains rangebound and, within the range, subject to support and a bounce right near these current levels.

And then there's Sylvia. How many times did we discuss that old dame 2-3 weeks ago, closely watching the $1735 level for a breakout? In the end, it's hardly a surprise that it didn't break out and what you see now is what always happens when a breakout fails. Namely, everyone attempts to head for the exits at once! The result is a sharp drop. But look what has happened. Successive attempts to press it even lower and under $1600 failed late last week and now she's likely primed for a sharp, short-covering, snapback rally.

So, in this context, what can we expect this week from the metals? First of all, anything is possible. You should know that by now. However, both charts are clearly oversold in the short-term and look poised for a rebound. We may even be able to generate some momentum and then create a virtuous cycle of short-squeezing. We'll see about that but, at a minimum, I am confident that the lows of last week are going to hold.

Of course, we may not get much today because of the expiration of the March13 silver options. We also need to keep in mind that Thursday will be First Notice Day so expect a lot of volatility. Again, though, I think we've found an end to this latest downdraft and I firmly believe that March is going to be very interesting and very fun. (Ides+7)

OK, now onto this backwardation stuff. As mentioned above, this will be a hot topic around here this week as I plan to record a podcast with our pal, Andy, either tomorrow or Wednesday. (It just kind of depends on how busy things are in the markets.) I also hope to visit with the ultimate expert in this topic, Sandeep Jaitly of The Gold Basis Service newsletter. My goal is to give you plenty of information so that you can make your own decision as to the significance of the data. Again, no one has all the answers and we must always be willing to study and learn.

So, what are we looking at when measuring for backwardation in gold and silver? (Particularly gold, which is NOT a commodity, it is a currency. Don't think so? Ask the Turks or the Iranians or the Chinese what they think.) For this purpose, we measure what are called the BASIS and the C0-BASIS. Well, what are those?

BASIS = Front delivery month Comex future bid vs the SPOT ask/offer.

Co-BASIS = SPOT bid vs Front delivery month Comex future ask/offer.

Let's put that in numbers. Let's say that SPOT is currently bid at 1579 and offered at 1580 and that the April13 contract is bid at 1580 and offered at 1581. This gives us a BASIS of 0 and a Co-BASIS of 2. This is fine and this is normal "contango". But when we speak of current backwardation, that's not what we have. When we see backwardation, it begins when the BASIS turns negative and the Co-BASIS moves toward zero. So, now another example:

SPOT is still at 1579 by 1580 but the future is also 1579 by 1580. Now the BASIS is -1 and the Co-BASIS is 1. This is mild backwardation. Nothing crazy and it could simply be caused by front month liquidation as we head toward contract expiration and First Notice Day...kind of like where we are now in March13 silver.

Alarm bells begin to ring when BOTH the BASIS and Co-BASIS move into negative territory. Again, for example, when SPOT is 1579 by 1580 yet the nearby future is 1578 by 1579. This creates measurable and actionable backwardation as the BASIS is now -2 and the Co-BASIS is now zero. Again, this could be just a temporary situation caused by overdone, waterfall declines and other, assorted Cartel shenanigans.

The key word, though, is TEMPORARY. When the Co-BASIS reaches into negative territory, arbitrage should almost immediately turn it back positive. WHY? Because at a negative C0-BASIS, you should be able to sell your physical on the spot market and then immediately purchase, with the intent of taking delivery, a front month futures contract. By doing so, you are locking in a RISK-FREE PROFIT. Again, you might be asking why and how?

Look at the numbers in the backwardation scenario above. You can sell 100 ounces of physical at $1579. You can then guarantee the return purchase of your physical in 2-6 weeks by buying a futures contract for $1578. You just made $100. Do that with 100 contracts and you make $10,000. Do that with 1000 contracts and you make $100,000. Do it every day for a week and you make $500,000. Because people are willing and able to do that, the backwardation closes and the market flips back into contango.

But here's the deal...April13 gold, which will expire in about 5 weeks, is now consistently in backwardation, not just on the BASIS but on the Co-BASIS, too. WHY??? Why aren't the arbitrageurs jumping at the free money? THAT is the question.

Later this week, when I speak with Andy, we'll attempt to definitively answer this question and provide a further explanation as to what this signals for future price. For now, though, I'm going to leave this right here for your discussion. If you want to do some of your own homework on this subject, I strongly suggest you start with this excellent piece from Dr. Antal Fekete. It's worth your time and very informative.

Have a great day. I look forward to a very interesting and exciting week.


About the Author

turd [at] tfmetalsreport [dot] com ()


Feb 26, 2013 - 4:20am

and a replay from November

and a replay from November related to my post above.

Basel III: Gold's Status as Tier 1 Asset Restored + Bank of Japan Monetary Policy, Competitive QE
Feb 26, 2013 - 4:17am

Just curios- if Sprott trust

Just curios- if Sprott trust shares are gold silver backed, are they used as safe currency? If that would be so, their value would be above gold/silver content into them.

Feb 26, 2013 - 4:14am

(No subject)


here is another one if you didn't get the first one.

Basel iii - An overview of the Basel iii framework
Feb 26, 2013 - 3:59am

@boatman- MMT

I understand they do not take debt seriously at all, based on USG based monetary system as it is , mostly, though they apply it to any country, but then of course exchange rate question comes into spotlight if country is not enough self sufficient. USA is an exemption.

On other hand, to get clear picture on debt based monetary systems principal functioning, they are much better than anyone as they spell it as it is. That is why i suggest to read there analysis part.

Now as to suggestions part... I read it because I am sure USA will engage in increased fiscal spending for one reason (war) or another ( unemployment) rather sooner than later, my guess is before 2014 elections definitely, and I would like to understand both the mechanics ( which MMT describes perfectly) and inflation risk ( which is obvious at some level ) as well as corresponding loss of trust in the USG treasury based monetary system. One thing is important to understand that high powered (US government debt + bank notes) is the basis of ALL money supply in the world. It is the bottom of the pyramid, and only it matters as far as gold prices as monetary metal are concerned.. but on other side there is the real economy ability to be dragged along that monetary expansion. As soon as it appears that real economy kind of drags along, gold price stagnates or drops in quite wide rabge since trust in the system is a bit restored despite the continuous increase in accumulated USG debt.

Of course, I do not agree- partly also given the strength of financial capital in politics, legislation, enforcement, tradition- that deficit spending will be allowed to debase USD continuously, inflating the USD denominated debts away. Hence I am all the time looking for mechanisms of reset where after brief period of plunging in NEW Japan style inflation hunting the USG will tie the USD to gold ( or the whole world CBs and governments together will do it). I think the political climate as well as inflation pressure for that might be ready after 2016 elections, not earlier. May be later, as we have seen things taking more time than we expect.

There are 3 things that need to happen to engineer reset that favours financial capital after fiscal spending erodes trust in USG treasury debt based world money:

1) The FED /USG or all CBs/banking system must collect enough monetary gold ( 60% of world above ground monetary metal at least, I think about 70-100 000 tons) .

2) If its done by withdrawing money supply by cancelling part of USG debt, then the gold will be lured to banks due to firesale drop in gold prices from highest level ( e.g. 10 000 USD) by around 50% or more

3) The banks will buy this gold with the USD accumulated in the reserves due to QE , so that will be inflationary as trillions of USD will be released in the market

4) There needs to be a windfall tax on gold capital profit as people and institutions sell it that both inflation from released old USD and other currencies is at check, AND USG gets the old dollars back, however, its still potentially profitable for people to sell gold at these prices. Of course, legislation putting a time window on gold sales, dropping prices or once again barring the private stocking might be used to extricate as much as possible gold from population/institutions. The windfall tax might be backdated as well.

5) The USG needs to pay down its debt to foreigners /private to a manageable level before moving onto gold standard, as huge debt in gold backed USD would be unbearable as it will immediately draw the gold reserves out of US control to the creditors. USG can use the old USD gained from windfall tax on gold sales to pay down the debt, thus moving via this loop QE generated reserves into covering of USG debt. The amount of reserves that FED has the ability to generate via QE is in principle unlimited, it is not necessary to buy only USG treasuries or mortgage backed assets- it can by anything- as congress decides. So the amount of excess reserves generated by QE could be larger than USG debt owned by FED.

6) This is still lousy, but after all this FED can set a price at which it will buy gold from banks, thus issuing a new gold backed USD. Whatever the ratio of this new USD to gold, this process in whole will ensure that economy starts to deflate, and the debts in USD which has lost some value during inflationary period, regain part of their value, but most importantly, the deflation leads to bankruptcy of overleveraged companies and individuals, ensuring that banks and creditors acquire real assets at foreclosure or firesale prices, which will give them the final netting out of PRE inflation debts- a loss on inflation will be matched by gain on real asset prices.

I think , more details will appear if this scenario is possible at all, but this is the one banks could accept- keep their petty politicians in place in 2016, then tell them to engage in deflation under the new slogan of correcting the asset bubbles and runaway inflation. This would tell me that the US might get a Republican or even Tea Party if needed President in 2016. There has to be inflation before that. And in no way that will give back freedoms to the people the state is taking away now- the only freedom they will get will be to part with their assets to feed the creditors.

Short term, until mid 2020 - ies this could be a solution until global depression transforms into military aggression of some form.

Or, something has to be done with usury as such, and dethroning of financial capital worldwide.

Feb 26, 2013 - 3:54am


We have 1600! Gold moving better than silver.

Feb 26, 2013 - 3:19am


Just rattling your cage. I always try to steer my women away from Breakfast, or any other meal, at Tiffany. I'd rather just stack. I'm a cheap bastard!!

Feb 26, 2013 - 2:41am

No no no…

You all have bypassed one of the sexiest icons of the century:

None of 'em holds a candle to Bettie Page

So what if she never starred in any television shows?

BohemianPuck Smith
Feb 26, 2013 - 2:35am


Now you're talking...

Feb 26, 2013 - 2:24am

GSR continues to play with a

GSR continues to play with a new uptrending (PMs down) fork but seems also to have found a resistance on a parallel line to the previous downtrending fork. These to form a triangle ( marked by circle) which must be resolved either way - either break upowards along new fork, or down back to the upper line of previous fork- by March 1st.

In the meantime, if break of triangle does not happen earlier, I expect in general sideways trading in the range that in silver has been marked by 29,25 high and 28, 25 low.

Besides, today silver is crossing the death cross- 50 d MA moves below 200 d MA.

Yesterday previous 29,25 support acted as exact resistance, so that seems to be in place now.

Am i wrong ( as I rely on Netdania) that we are seeing significant volume increases in silver over last 3 out of 4 trading days ? What could that mean, such increase in activity in relatively flat and low place? Today with Bernanke speaking, trading can be active as well? See chart below:

Feb 26, 2013 - 2:19am


Now I see why Turd only get 2 "Likes" on his posts. ;-)

I used my other funny name to sign up just to see a friend's pictures. Immediately six people wanted to be "friends" with the guy with the funny name? Including some guy from Indonesia who doesn't speak (type) english. I posted mainly Ron Paul stuff during the election and now "like" & recommend doom & gloom articles and gold/silver stuff... No responses. More for my own reference. ;-)

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