Gold and Silver Backwardation

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 bells...at 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+7cool)

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.

http://www.professorfekete.com/articles/AEFGoldFever.pdf

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

TF

273 Comments

Xty's picture

Just to drive the lads mad

and I kid you not, I have seen Diana Rigg naked.  From a distance, and in the late 70's, but I haven't forgotten, and I am not really inclined that way myself.  (I remember your moral failings, Boatman, but you seem to have learned your lesson.)

As to trolls, I see that the Dow went to historic highs and gold fell 100-200 dollars!  

Or was that 120?  What's a little exaggeration amongst friends.  

Something very exciting certainly happened with the Euro/USD - I am fully with boatman on the inability of government/conspiracy to pull of tightly controlled coordinated plans for long, and the G20 meeting, with their pledge to let the market operate in currency exchange, in theory, but never in practice, seemed to me to be a real stale-mate.

Good Morning, too.

Louie's picture

@Xty govt and farms

Ever read Louis and Clarks first hand reports of their journey across America? Bison roaming free as far as the eye could see.

achmachat's picture

ah... stars of days past...

Beastly Stack's picture

The Bernank Today

Should be another fun day. If trading other than the metals, you may want to read this latest

http://tradermartinstake.com/

Hammer's picture

Surely Rita Heyworth ? 

Surely Rita Heyworth ? 

maravich44's picture

the fuse..

.

Hammer's picture

Ho hum, back to business

Xty's picture

re govt/farm analogy

One would need to know the number of heads of cattle now, vs then, which a cursory search has not helped me with, as cattle seem measured in pounds.  But my complaint was with the analogy - people can't live without government = animals couldn't live without farms (which I turned into farmers).   Not meaning to derail things, but it just isn't equivalent.  If farms were run by animals, as George Orwell intimates, then we could possible learn something from this.  I am a poster of cartoons myself, and sometimes they (I don't mean just the ones I post) can be profound, but this one missed the mark.  Or maybe I am just tired of the sheep/masters line of thinking.  Our government is run by flawed humans, as dumb as the sheep they try to pen, if not dumber.  The farmer, on the other hand, has a distinct advantage over his (or her) livestock, an advantage I refuse to cede to my ostensible 'leaders'.

Puck T. Smith's picture

I'm liking Greg Mannarino more every day.

Louie's picture

Govt farms

I understood it to mean that animals can live without farms just like people can live without governments.

Being a student of military history wars became immensely larger and more deadly with the rise of the nation state.

Louie would greatly prefer to be left alone by governments.

¤'s picture

Billions (Trillions?) In Losses & Fancy Fed Napkins

Fed Faces Explaining Billion-Dollar Losses in Stress of QE3 Exit

Melissa Golden/Redux
Bernanke’s efforts to rescue the economy could result in more than a half trillion dollars of paper losses on the central bank’s books if interest rates rise abruptly from recent levels.

Federal Reserve Chairman Ben S. Bernanke’s efforts to rescue the economy could result in more than a half trillion dollars of paper losses on the central bank’s books if interest rates rise abruptly from recent levels.

That sum is the difference between the value of securities in the Fed’s portfolio on Dec. 31 and what they may fetch in three years, according to data compiled by MSCI Inc. of New York for Bloomberg News. MSCI applied scenarios devised by the Fed itself for stress-testing the nation’s 19 largest banks.

MSCI sees the market value of Fed holdings shrinking by $547 billion over three years under an adverse scenario that includes an economic contraction and rising inflation. MSCI puts the Fed’s mark-to-market loss at less than half that, or $216 billion, if the economy performs in line with consensus forecasts of gradually rising growth, inflation and interest rates.

The potential losses are unprecedented in the Fed’s 100- year history, and Bernanke has never used congressional testimony to give a detailed explanation of the consequences of shifting hundreds of billions in interest-rate risk from private portfolios onto the Fed’s balance sheet. Today, Bernanke appears before senators who oversee the Fed and may face questions on how the $3.1 trillion balance sheet will affect an exit from the stimulus program, remittances to taxpayers, and its ability to stabilize inflation expectations.

“You can easily imagine a naive congressional response, which is ‘Where did the money go?’ ” said Sarah Binder, a senior fellow at the Brookings Institution who researches the relationship between the Fed and Congress. “Even if there’s a perfectly logical explanation and the normalization of the balance sheet is a good thing in the long term, the headlines will probably generate congressional scrutiny,” said Binder. “That’s never a good thing from the Fed’s perspective.”

Recession Battle

The risk of mark-to-market losses under some scenarios is the price of Bernanke’s battle to overcome the deepest recession since the Great Depression as the Fed embarked on three rounds of so-called quantitative easing. The benefit is more jobs and higher growth, Fed officials say.

The first two rounds of bond purchases “may have raised the level of output by almost 3 percent and increased private payroll employment by more than 2 million jobs, relative to what otherwise would have occurred,” Bernanke said in an Aug. 31 speech in Jackson Hole, Wyoming.

‘Diminishing Returns’

“There’s a cost to very significant stimulus -- and that’s OK if the stimulus is a good investment -- and I think a lot of what the Fed has done is a very, very good decision,” said Representative John Delaney, a Maryland Democrat and member of the House Financial Services Committee, where Bernanke testifies tomorrow. “Their actions right now are having diminishing returns and increasing the severity of this future loss that will be incurred as rates go up.”

The Fed doesn’t mark its portfolio to market, and its losses may be only a fraction of MSCI’s totals because the central bank could hold the bulk of its assets to maturity. The central bank cannot go bankrupt and can continue to operate with losses on its books.

Bernanke’s legacy will be judged in part by how the Fed exits from.....

http://www.bloomberg.com/news/2013-02-26/fed-faces-explaining-billion-dollar-losses-in-stress-of-qe3-exit.html

maravich44's picture

musical interlude....

and opps to que up the IU.

Groaner's picture

Battle royal for $1600 today?

much different action going on that's for sure.. it wont be long.

Lots of buy stops just above 1600 I would imagine..

i had a 1602.8 sell in, instead of .20 ,,still a close guess.

Chibster's picture

The Real Bank

The Local Coin Shop is what I consider the only "real bank" in my town.  The LCS holds the only real money worth holding that cannot be debased via printing press and is hyperinflation proof.  I only hold fiat FRN Monopoly money to "play the game".  The LCS lets me earn interest rates higher than the Bernanke APR.

Monedas's picture

I called the bottom on Sunday !

With typical Monedian swagger and bluster .... I taunted Bernanky .... by slapping his pee pee .... with my sequinned glove .... and dared him to make a liar out of me !     Don't I get a yellow hat .... for that ?    This would be a good time to list the entrants to the gold and silver end of March spot price guessing contest and their guesses .... the guessing window is closed .... and my somewhat whimsical guesses are now in play .... big time !       Monedas     1929        Comedy Jihad North Korea Will Launch When Their Great Leader Is Making A Diplomatic Visit To Sardinia To Highlight The North Korean Community In Cagliari World Tour    devil

Puck T. Smith's picture

Serious question for traders.

What is the best platform for a beginner?  Ameritrade? Scott? Help me out here.  I have a little cash and I want try my hand.  I know I'm going to hear a chorus of "Don't do it!", but that is not what I'm looking for.  I'm a grown up, I'm willing to take responsibility for my own decisions.  I believe there is a good opportunity to make some fiat off the collapse of fiat.  I've let too many opportunities pass in my life.  If I don't try I'm guaranteed to fail.

Edit to add: I'm not talking about trading metals, at least not yet, I'm talking about equities.

heyJoe's picture

@ClinkinKY

yesyesyes

My wife prefers her AR-15 over a shotgun.

Groaner's picture

@Puck

I have used Ameritrade for a long time now,,, no problems.

atomic180's picture

I'll be moving to SCOTT...

from Vanguard due to increased trading costs... though many of the other platforms have free trades to new customers and in some cases cash depending on account size... generally Scott is used and approved by people I know... good luck "Its a cold world out there"

¤'s picture

Ides of March +7 / My Guess

My specific guess would be that on or very close to that date that Jim Sinclair and a select group of big money are all pooled up (right now) and are going to stand for a golden delivery they know can't be met.

In a nutshell....JS is about to give himself and everyone a big B-Day gift and attempt to physically crack the golden market egg open.

Best of luck to Jim and his associates on this endeavor! yes

gold.span.jpg

Harald's picture

Puck

I use Optionsxpress.  Great trading platform and tons of useful tools.  Also, owned by Charles Schwab who supposedly doesn't hypothecate customer funds. 

Dr Jerome's picture

Trading Platform

I was steered to ThinkorSwim by my mentor. He called it the best platorm out there for small traders. No regrets. TD Ameritrade bought them out and really did not change the guts of the platform. Their support staff on the phone is incredibly patient and helpful. They have some incredible charting tools as well as the ability to back-test a trading strategy. But it took me quite a while to learn.

Urban Roman's picture

Questions for Traders

I too have trader questions. 

How does one determine how, exactly, a given broker settles a trade? For example in metals ... if I'm not a member at the LBMA, then my little bid/ask has to pass through some other hands. So If I use a little local broker here in Jollyville, and then my trade is sent on to House of XYZ in San Antonio, and then it goes on to another place on Wall St., by the time it gets there it has to wait in line behind the rest of Turd's Army and Andy's other followers.

I guess it's the same question posed by the HFTs who co-locate their servers at the exchange so their 'bots can better rip off the sheep.. 

napa698's picture

@Puck

I have been using Schwab for 12 years no problems love their platform,i do it all day every day i would be glad to help.

boatman's picture

governments

people are not like animals...........at a certain population density level......some sort of  government is required.

wish it wasn't soooo

murphy's picture

New thread btw

New thread btw

القراع عصفور's picture

Puck

Puck - i'd look at sites like this to get an idea of how the various platforms differ...

http://www.consumersearch.com/online-brokers

i have only ever used Fidelity and Scottrade, and have no complaints with either.  i think you need to compare the platforms yourself though and decide what fits your trading style - if you even have one yet.  i don't think too many folks switch accounts once they get comfortable with what they are using, but everyone speak up if i am wrong.

Motley Fool's picture

DPH

Then I hope they have deep pockets. I estimate it would take at least $50 billion cash to even try to break the market, and even that is likely not enough.

Motley Fool's picture

double

.

SIlverbee's picture

Zerohedge

Down?

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