Gold and Silver Backwardation

273
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 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+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.

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

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

TF

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turd [at] tfmetalsreport [dot] com ()

  273 Comments

Mr. Fix
Feb 25, 2013 - 4:34pm

How I do lunch...

I just can't "let it go"!

Mr. Fix
Feb 25, 2013 - 4:41pm

Kcap:

Just got this 1 minute ago:

Hi there,

We wanted to thank you for your patience with us as we work through our engineering, architecture and design phases as we are readying Galt's Gulch Chile for lot sales. Our new GGC team members will be reaching out to all of the many inquiries which we receive each day, which are now flowing in at well over 1,000 per month! Things tend to move in a bit more of a 'tranquilo' manner in South America, which is a great thing of course! …but, this wonderful pace of life has also slowed progress a bit throughout January and February, with much of the Chilean population taking a large part of February off for vacation, but we have continued to get those things done that we are able to, with our engineering and architecture teams working right now to complete the lot layout options for the first phases of lot sales at GGC! Our Santiago headquarters has been located and we plan to be moving into this location in early March, with our on-site office currently being updated and retro-fitted with off-grid renewable power, high efficiency lighting and the like, with it being available for use sometime in March for both sales purposes and also for those interested in the community to spend the night under the stars in the serenity of the gulch and cooking up some great food on the grill! Our staff is always available for site tours, so if you want to plan your trip down to meet with us, please do so anytime…and just remember to schedule a time, or times, for our staff to meet with you and give you a tour of the land! If you are in Chile now, don't hesitate to do so as well! Please use the following email addresses for further information: sales[at]galtsgulchchile[dot]com for information on lot sales and home sales foundersclub[at]galtsgulchchile[dot]com for information on The Founder's Club at Galt's Gulch, which offers tremendous opportunities for those who get involved now! staff[at]galtsgulchchile[dot]com for information on becoming part of the GGC team or opportunities to work with us on the project in areas of construction, engineering, design, implementation, etc. Please also 'like' us on Facebook to see new photos and information! www.facebook.com/galtsgulchchile As always, we thank you for your interest in GGC…and do sincerely look forward to getting to know you! To your freedoms,

Galt's Gulch Chile

www.galtsgulchchile.com

ag1969
Feb 25, 2013 - 4:47pm

For those of you that live in NH

The Barn Store in Salisbury has copious amounts of .22LR if you are willing to pay 34.99 for 500 rounds.

¤
Feb 25, 2013 - 4:48pm

Mex 50 peso

It's a beautifully hefty coin with a palmability factor of 9. It feels in your hand how a serious coin should feel...heavy and sizable.

If I could post a pic of one right now I would. It has unique patina to it from the copper content and the 1.2 ozs. of Au mixed in and design is beautiful.

knavechild
Feb 25, 2013 - 4:50pm

At my ropes end.

Does anyone else feel like they are living in the twilight zone?

On one hand I watch my Facebook feed fill up with photos of people's lunch plates and comments about how great Michelle Obama was on the Oscars, and then on the other end, I'm watching a global currency war with nearly all fiat being devalued, talk of war with Iran, an outbreak of TB in Los Angeles, North Korea testing nukes, Fukushima pouring out radiation all over the northern hemishere, U.S. government trying to destroy the constitution and confiscate people's firearms, fusion centers and alphabet agencies trying to spy on the population and label law abiding citizens as terrorists, governments all over the world buying up huge hordes of precious metals, gas prices going through the roof.....ON AND ON AND ON.

Is it just me, or does a large portion of the human population of Earth resemble ABSOLUTE TOTAL BRAINDEAD ZOMBIES?

What drugs are these people taking that keeps them so blissfully unaware that our civilization is in a state of near total meltdown?

If I don't close my facebook account soon, I'm going to have a nervous breakdown at some point watching the zombies post pictures of their food all day!

Sorry, just needed to get that out.

-Knavechild

delacroix
Feb 25, 2013 - 4:57pm
Gold_Price
Feb 25, 2013 - 5:05pm

Great Post - Gold Price

Great post. The truth of the matter is that the gold price will inevitably continue increasing in the long run as currency wars rage and central banks keep buying like mad. In order to maximize investment potential with gold, we must invest accordingly and keep a close eye on the gold price at https://www.goldprice.net

CrimsonAvenger knavechild
Feb 25, 2013 - 5:08pm

At my rope's end as well

Knavechild, you're not the only one baffled by people's refusal to become aware of their surroundings. Last week, I finished work on a 10-page paper, clearly outlining why I thought we were all in big trouble. It was a piece for beginners - to help them see what we all saw - and I really wrote it for my wife, who doesn't fuss too much about my stacking/prepping, but absolutely thinks things are going to be fine.

I gave my wife this paper. She read it. Her response was twofold. First, she simply said "I can't see any of this happening." Next, she spent 30 seconds on google, found an article by Paul Krugman, and emailed it to me as a contrarian point of view.

If you have a nervous breakdown, I guess we can have a drink together at the asylum, cause I'm right there with you.

Kcap
Feb 25, 2013 - 5:11pm

@fix

Thanks. Interesting......time to ponder.

Are you going to inquire further?

Kcap

¤
Feb 25, 2013 - 5:15pm

Rod Serling...

...and myself agree with you on the surreality of life at times.

Maybe ignorance, avoidance or denial of unpleasant things is bliss defined.

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