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Wednesday, July 24, 2013 3:01 AM


Gold Backwardation Conspiracy Nonsense


Business Insider says "Traders Are Talking About A Gold Conspiracy Theory And There's Evidence To Back It Up"

No discussion about gold is complete without a good conspiracy theory. While most theories are easily dismissed, some stay around for a while due to a confluence of circumstantial evidence surrounding it. Wall Street veteran Art Cashin addresses one such theory in this morning’s Cashin’s Comments.

From Cashin:

All That Glitters Is Not Arbitrage – Monday, spot gold spiked up $45 and the media pundits pointed to things from China to the FOMC. While all the cited may have been factors, veteran traders saw the bulk of the move resting in a conspiracy story.

In my mid-day email to friends I had noted this:

Gold soars as NYT story on metal warehouses fans flames of conspiracy theorists that gold warehouse stores have been “lent” out. That theory also aided by backwardation (spot price far above near future).....

Unfortunately, we are not sophisticated enough to answer these questions.  But email us at moneygame@businessinsider.com if you can.
Email is on the Way

Consider what follows as my email to Business Insider and Cashin.

People like conspiracy theories for two reasons:

  1. Conspiracy theories are sexy and fun to discuss
  2. Traders want to blame someone else for their poor trades.

Simply put, if gold goes up, it's because it should (and the traders are brilliant for understanding that). If gold gold down, it must be a conspiracy (because the traders cannot possibly be wrong).

Investigating Backwardation

My friend Nick at Sharelynx Gold emailed me earlier today regarding the alleged backwardation in gold.

Nick writes....
Hello Mish

The attached chart shows gold's current spread band of all the active futures vs the spot price of gold. Shown in the top window are the active futures. Shown in the bottom window is the Last/Near Future spread. (this needs to go below zero for a full inversion)

Gold Futures Spread



click on any chart for sharper image

Gold Chat

Bron at Gold Chat posts the following amusing set of charts that may be easier to understand.

Gold Futures Spread



Oil Futures Spread



Now That's Backwardation!

Recall the definition of backwardation: Current price above future delivery price.

There are many reasons this can happen with commodities, but the typical explanations are: temporary short-term supply shortage, expected future supply, or expected falling demand.

Supposedly this can never happen with gold because "gold is money".

Leaving aside the philosophical question as to whether or not gold is money, presume for a moment that it is.

Using the above oil chart as a basis (assuming the gold chart were the same), backwardation implies that someone could borrow money today and pay it back in 2018 for 80 cents. Logically, that shouldn't happen.

Acting Man Chimes In

My friend Pater Tenebrarun at the Acting Man Blog (see his recent post Gold and Gold Stocks – More Signs of Life) chimed in with this email comment:
There is no persistent and deep backwardation in gold, so it is definitely not something to get alarmed over just yet. However, it is still notable that the nearby futures repeatedly slip into slight backwardation versus spot. Moreover, the gold forward rate has recently turned negative. That means that people are now paying more interest for gold in a gold-dollar swap than for dollars. That happens only rarely. Of course all of this happens mainly because interest rates are so low. If interest rates were higher, then it would really be worth getting exercised over. Still, GOFO only rarely turns negative and it often marks a low when that happens.
Philosophical Question

The philosophical question regarding whether or not "gold is money" is an interesting one.

If indeed "gold is money" (not an ordinary commodity like corn, copper, or oil), then severe backwardation implies skepticism as to whether future gold contracts will really be delivered.

Thus, backwardation claims fuel all sorts of theories about gold shortages, gold leasing, and price suppression.

However, the charts provided by Nick at Sharelynx and Bron at Gold Chat show that claims of backwardation are essentially nonsense.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com


Copyright 2009 Mike Shedlock. All Rights Reserved.
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