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Backwardation in Gold And Silver

Keith Weiner
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Wednesday, May 16th

On Monday, May 14, something happened that hasn’t happened since Dec of 2008. Two successive near-month precious metals futures contracts were in backwardation at the same time. To oversimplify, backwardation is when the price of a futures contract is lower than the price in the spot market. It should not be possible for it to happen in gold and silver (see my piece http://keithweiner.posterous.com/when-gold-backwardation-becomes-permanent).

But ever since Dec 2008, it has been recurring intermittently, and recently it has become the “new normal” for each futures contract to head into backwardation before expiring (see http://keithweiner.posterous.com/temporary-backwardation-the-path-forward-from).

Even in this “new normal”, however, it has been only one at a time: one metal, and one month. This is because the backwardation occurs with the “contract roll”, as people sell the expiring contract and buy one farther out. The selling pressure on the expiring contract is most intense for a short period of time. After that, the spread widens as the market makers move on, the selling pressure abates, and with wider spreads all around, both the basis and cobasis fall into oblivion. Except for the December month, gold and silver futures are liquid in different months.

That is why one does not see both monetary metals in backwardation simultaneously because they are “out of phase” by 30 days and temporary backwardation typically persists for only about a week or so. And it should be even harder to see two different successive near-dated futures contracts in backwardation.

On May 14, this is precisely what occurred. Both May and July silver are backwardated. And June gold is backwardated. Incredibly, the May silver contract is giving away a 3% annualized profit to anyone who would sell physical silver and buy a May future that delivers in a few weeks (thus recovering the same position). Even more incredibly, no one can or will take the profit that is dangling out there!

July silver backwardation is smaller, and June gold backwardation is even smaller. But still! This should not be possible at all.

Because the next successive contracts are not in backwardation (in silver, all contracts from Jul 2015 on are backwardated), it is not a collapse of trust. I think that it is a lack of unencumbered metal. The markets for precious metals, silver more than gold, have become quite tight.

Keith Weiner

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