Silver in Backwardation; Has the Last Cantango Been Danced in Washington?

February 02, 2009

As we learned in "The Significance of Gold Backwardation Explained (4/5)", backwardation is a sign of a very tight market, and a market that will be tight for sometime into the future either because: 1) current supply is very tight, 2) future supply is projected to be very tight, or 3) there is a severe distrust in counterparties that the short positions can deliver the goods on time per the contract, or vice versa that the long positions will not have the cash.]

While gold traded as a "store of value" (a currency, really), very little is actually consumed. Silver, on the other hand, serves as both an industrial metal and a "store of value" for silver investors. As we learned here, both silver and gold are precious metals since there is very little above ground stock. All of the gold stock in the world would fit into a cube 20.5 meters to a side. Due to high amounts of industrial usage, the silver stock is even smaller, less than 14.5 meters to a side.

Please refer to the below graphs (click to enlarge) of LBMA's silver mid rate, which is the midway point between the bid and offer prices. Here is what I note:

• Silver for all traded futures contracts (whether 1 month or 12 months) have been in backwardation for seven trading days since January 21.
• This backwardation is about three times more severe than the mild backwardation than existed from December 8 through December 24 in 2008.
• We can see that since 2006-2007 where rates were about 4-5%, this state of backwardation is fairly unusual. (The LBMA only lists data back to 2006, but I believe it is a fair comment to say that on an even longer timeline, this is unusual.)
• Furthermore, starting in roughly June 2008, the 12-month SIFO rate flipped over from being the lowest rate to, in general, the highest.
• Also, the disparity between the rates seen in 2006-2007 has largely disappeared; the market appears to be treating a trade on silver 12 months later as quite similar to a trade on silver 1 month later.

[All graphs in this article were created by author from this LBMA source.]

Let's now also look at the LBMA Silver Fix price history for a 1000 troy ounce bar. While at the end of the graph, the loss of purchasing power relative to the euro and dollar by the British pound can easily be seen, I remark that despite all of the tightness in the market as demonstrated by the SIFO chart, the price of silver is still well below the average price for 2006-2008.

It is simply too early to tell if we have seen the "Last Contango," but as Dr. Fekete notes in "The Last Contango in Washington" (2006) and "Keeping Our Eyes Peeled for the Silver and Gold Basis" (2007), the consequences could be very stark for the dollar and hence all fiat currencies.

Now, of course, there are many other factors as silver guru Theodore Butler points out in "Tightening Production". Industrial demand has been slammed by the economic fallout. However, since about 70% of all silver is typically mined as a by-product with other base metals like zinc, the supply is also greatly affected by the market conditions of zinc, copper, lead, and nickel. While the backlog in demand has greatly increased the inventories of these base metals causing a drop in their prices, the inventory of silver is growing smaller while the price has increased over the past three months from $10 to $12/oz.

Butler also relates that many of the base metal mines have been closing since they are no longer profitable. At the same time, Butler reports that the American COMEX silver futures market is under investigation by the CFTC (Commodities and Futures Trading Commission) for market manipulation and price suppression. However, since the market is located in London, I suppose this backwardation could also be temporary due to the severe loss of purchasing power (relative to others) of the British pound.

[For the Reader, NYMEX Gold Session Futures chart, Silver Session Futures chart. Gold spot price chart. Silver spot price chart. When the spot price is greater than the futures price, backwardation exists.]

Let's now take a quicker look at gold traded at LBMA. The GOFO, or Gold Forward Offered Rate, represents the rates at which dealers will lend gold on a swap basis against US dollars. From the below charts, I note:

• Recently, gold has only gone into minor backwardation once, in November 2008, for 3 days.
• As GOFO started its plummet in roughly September 2007, the prices began to diverge, and currently the 1-month GOFO rate is lower than the 12-month rate.
• Again, the buckling of the British pound can be easily seen.
• The British pound set an all-time high of 656 pounds per ounce of gold this week on January 26, 2009.
• The euro set an all-time high of just under 700 euros per ounce of gold this week on January 26, 2009.
• Gold priced in dollars is still 14% below its 2008 high of $1,023, as of January 29.

The reader should be aware I highlighted in my last article "GATA's Message on Gold and Silver Manipulation to Barack Obama (PART 2/2)" and support the group known as GATA in their battle to bring about an end to the suppression that I perceive exists from the evidence GATA has gathered. As the GOFO rate is just barely positive (+0.2%) as I write, I warn you of what will happen if gold lapses into permanent backwardation. Or rather, I will let James Turk of goldmoney.com warn you:

If gold does trade in backwardation against the US dollar for a protracted period..., it will mean that a collapse of the dollar has begun. Think about it. How could gold go into backwardation for any prolonged period? If it does, it would mean that no one is willing to take the risk of selling their hoard and instead hold US dollars. It would mean that no one is willing to accept the risks that come with holding dollars while waiting until they can be used at a future date to exchange back into gold.

Got silver? Got gold? To those I believe who are suppressing the free market of these two monetary metals, my message is from this Offspring video full of gold and silver coins:

So dance, ******, dance!
...Hit ‘em right between the eyes!
Hit ‘em right between the eyes!
When you walk away,
Nothing more to say!
See the lightning in your eyes!
See ‘em running for their lives!

Everyone else, get some while it is still cheap!

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