RED ALERT: GOLD BACKWARDATION!!!
by Antal E. Fekete,
Gold Standard University Live
December 5, 2008

December 2, 2008, was a landmark in the saga of the collapsing international monetary system, yet it did not deserve to be reported in the press: gold went to backwardation for the first time ever in history. The facts are as follows: on December 2nd, at the Comex in New York, December gold futures (last delivery: December 31) were quoted at 1.98% discount to spot, while February gold futures (last delivery: February 27, 2009) were quoted at 0.14% discount to spot. (All percentages annualized.) The condition got worse on December 3rd, when the corresponding figures were 2% and 0.29%. This means that the gold basis has turned negative, and the condition of backwardation persisted for at least 48 hours. I am writing this in the wee hours of December 4th, when trading of gold futures has not yet started in New York.

According to the December 3rd Comex delivery report, there are 11,759 notices to take delivery. This represents 1.1759 million ounces of gold, while the Comex-approved warehouses hold 2.9 million ounces. Thus 40% of the total amount will have to be delivered by December 31st. Since not all the gold in the warehouses is available for delivery, Comex supply of gold falls far short of the demand at present rates. Futures markets in gold are breaking down. Paper gold is progressively being discredited.

Already there was a slight backwardation in gold at the expiry of a previous active contract month, but it never spilled over to the next active contract month, as it does now: backwardation in the December contract is spilling over to the February contract which at last reading was 0.36%. Silver is also in backwardation, with the discount on silver futures being about twice that on gold futures.

As those who attended my seminar on the gold basis in Canberra last month know, the gold basis is a pristine, incorruptible measure of trust, or the lack of it in case it turns negative, in paper money. Of course, it is too early to say whether gold has gone to permanent backwardation, or whether the condition will rectify itself (it probably will). Be that as it may, it does not matter. The fact that it has happened is the coup de grâce for the regime of irredeemable currency. It will bleed to death, maybe rather slowly, even if no other hits, blows, or shocks are dealt to the system. Very few people realize what is going on and, of course, official sources and the news media won’t be helpful to them to explain the significance of all this. I am trying to be helpful to the discriminating reader.

Gold going to permanent backwardation means that gold is no longer for sale at any price, whether it is quoted in dollars, yens, euros, or Swiss francs. The situation is exactly the same as it has been for years: gold is not for sale at any price quoted in Zimbabwe currency, however high the quote is. To put it differently, all offers to sell gold are being withdrawn, whether it concerns newly mined gold, scrap gold, bullion gold or coined gold. I dubbed this event that has cast its long shadow forward for many a year, the last contango in Washington �?contango being the name for the condition opposite to backwardation (namely, that of a positive basis), and Washington being the city where the Paper-mill of the Potomac, the Federal Reserve Board, is located. This is a tongue-in-cheek way of saying that the jig in Washington is up. The music has stopped on the players of ‘musical chairs�? Those who have no gold in hand are out of luck. They won’t get it now through the regular channels. If they want it, they will have to go to the black market.

I founded Gold Standard University Live (GSUL) two years ago and dedicated it to research of monetary issues that are pointedly ignored by universities, government think-tanks, and the financial press, centered around the question of long-term viability of the regime of irredeemable currency. Historical experiments with that type of currency were many but all of them, without exception, have ended in ignominious failure accompanied with great economic pain, unless the experiment was called off in good time and the authorities returned to monetary rectitude, that is, to a metallic monetary standard. It is also worth pointing out that the present experiment is unique in that all countries of the world indulge in it. Not one country is on a metallic monetary standard, under which the Treasury and the Central Bank are subject to the same contract law as ordinary citizens. They cannot issue irredeemable promises to pay and keep them in monetary circulation through a conspiracy known as check-kiting. Not one country will be spared from the fire and brimstone that once rained on the cities of Sodom and Gomorrah as a punishment of God for immoral behavior.

In all previous episodes there were some countries around that did not listen to the siren song and stayed on the gold standard. They could give a helping hand to the deviant ones, thus limiting economic pain. Today there are no such countries. If you want to be saved, you must be prepared to save yourself.
You cannot understand the process whereby a fiat money system self-destructs without understanding the gold and silver basis. The Quantity Theory of Money does not provide an explanation, because deflation may well precede hyperinflation, as it appears to be the case right now.

For these reasons I placed the study of the gold and silver basis on the top of the list of research topics for GSUL. These can serve as an early warning system that will signal the beginning of the end. The end is approaching with the inevitability of the climax in a Greek tragedy, as the heroes and heroines are drawn to their own destruction. The present reactionary experiment with paper money is entering its death-throes. GSUL has had five sessions and could have established itself as an important, and even the only, source of information about this cataclysmic event: the confrontation of the Titanic (representing the international monetary system) with the iceberg (representing gold and its vanishing basis) as the latter is emerging from the fog too late to avoid collision.

Unfortunately, this was not meant to be: GSUL has to terminate its operations due to a decision made by Mr. Eric Sprott, of Sprott Asset Management, to terminate sponsoring GSUL, saying that “results do not justify the expense.�?/P>

I sincerely regret that our activities did not live up to the expectations of Mr. Sprott, but I am very proud of the fact that our research is still the only source of information on the vanishing gold basis and its corollary, the seizing up of the paper money system that threatens the world, as it does, with a Great Depression eclipsing that of the 1930’s.

Let me summarize the salient points of discussion during the last two sessions of GSUL for the benefit of those who wanted to attend but couldn’t. The gold basis is the difference between the futures and the cash price of gold. More precisely it is the price of the nearby active futures contract in the gold futures market minus the cash price of physical gold in the spot market. Historically it has been positive ever since gold futures trading started at the Winnipeg Commodity Exchange in 1972 (except for some rare hiccups at the triple-witching hour. Such deviations have been called ‘logistical�?in nature, having to do with the simultaneous expiry of gold futures and the put and call option contracts on them. In all these instances the anomaly of a negative basis resolved itself in a matter of a few hours.)

In the commodity futures markets the terminus technicus for a positive basis is contango; that for a negative one, backwardation. Contango implies the existence of a healthy supply of the commodity in the warehouses available for immediate delivery, while backwardation implies shortages and conjures up the scraping of the bottom of the barrel. The basis is limited on the upside by the carrying charges; but there is no limit on the downside as it can fall to any negative value (meaning that the cash price may exceed the futures price by any amount, however large).

Contango whereby the futures price of gold is quoted at a premium to the spot price is the normal condition for the gold market, and for a very good reason, too. The supply of monetary gold in the world is very large relatively speaking. Babbling about the ‘scarcity of gold�?reflects the opinion of uninformed or badly informed people. In terms of the ratio of stocks to flows the supply of gold is far and away greater than that of any commodity. Silver is second only to gold. It is this fact that makes the two of them the only monetary metals. The impact on the gold price of a discovery of an extremely rich gold field, or the coming on stream of an extremely rich gold mine, is minimal �?in view of the large existing stocks. Paradoxically, what makes gold valuable is not its scarcity but its relative abundance, which evokes that superb confidence in the steadiness of the value of gold that will not be decreased by a banner production year, nor can it be increased by withdrawing gold coins from circulation. For this reason there is no better fly-wheel regulator for the value of currency than gold. The same goes, albeit to a lesser degree, for silver.

Here is the fundamental difference between the monetary metal, gold, and other commodities. Backwardation will pull in stocks from the moon as it were, if need be. The cure for the backwardation of any commodity is more backwardation. For gold, there is no cure. Backwardation in gold is always and everywhere a monetary phenomenon: it is a reminder of the incurable pathology of paper money. It dramatizes the decay of the regime of irredeemable currency. It can only get worse. As confidence in the value of fiat money is a fragile thing, it will not get better. It depicts the paper dollar as Humpty Dumpty who sat on a wall and had a great fall and, now, “all the king’s horses and all the king’s men could not put Humpty Dumpty together again.�?To paraphrase a proverb, give paper currency a bad name, you might as well scrap it.

Once entrenched, backwardation in gold means that the cancer of the dollar has reached its terminal stages. The progressively evaporating trust in the value of the irredeemable dollar can no longer be stopped.

Negative basis (backwardation) means that people controlling the supply of monetary gold cannot be persuaded to part with it, regardless of the bait. These people are no speculators. They are neither Scrooges nor Shylocks. They are highly capable businessmen with a conservative frame of mind. They are determined to preserve their capital come hell or high water, for saner times, so they can re-deploy it under a saner government and a saner monetary system. Their instrument is the ownership of monetary gold. They blithely ignore the siren song promising risk-free profits. Indeed, they could sell their physical gold in the spot market and buy it back at a discount in the futures market for delivery in 30 days. In any other commodity, traders controlling supply would jump at the opportunity. The lure of risk-free profits would be irresistible. Not so in the case of gold. Owners refuse to be coaxed out of their gold holdings, however large the bait may be. Why?

Well, they don’t believe that the physical gold will be there and available for delivery in 30 days�?time. They don’t want to be stuck with paper gold, which is useless for their purposes of capital preservation.

December 2 is a landmark, because before that date the monetary system could have been saved by opening the U.S. Mint to gold. Now, given the fact of gold backwardation, it is too late. The last chance to avoid disaster has been missed. The proverbial last straw has broken the back of the camel.

I have often been told that the U.S. Mint is already open to gold, witness the Eagle and Buffalo gold coins. But these issues were neither unlimited, nor were they coined free of seigniorage. They were sold at a premium over bullion content. They were a red herring, dropped to make people believe that gold coins can always be obtained from the U.S. Mint, and from other government mints of the world. However, as the experience of the past two or three months shows, one mint after another stopped taking orders for gold coins and suspended their gold operations. The reason is that the flow of gold to the mints has become erratic. It may dry up altogether. This shows that the foreboding has been evoked by the looming gold backwardation, way ahead of the event. Now the truth is out: you can no longer coax gold out of hiding with paper profits.

If the governments of the great trading nations had really wanted to save the world from a catastrophic collapse of world trade, then they should have opened their mints to gold. Now gold backwardation has caught up with us and shut down the free flow of gold in the system. This will have catastrophic consequences. Few people realize that the shutting down of the gold trade, which is what is happening, means the shutting down of world trade. This is a financial earthquake measuring ten on the Greenspan scale, with epicenter at the Comex in New York, where the Twin Towers of the World Trade Center once stood. It is no exaggeration to say that this event will trigger a tsunami wiping out the prosperity of the world.

References

By the same author:

The Rise and Fall of the Gold Basis, June 23, 2006
Monetary and Non-Monetary Commodities, June 25, 2006
The Last Contango in Washington, June 30, 2006
Gold, Interest, Basis, March,7, 2007
Gold Vanishing into private Hoards, May 31, 2007
Opening the Mint to Gold and Silver, February 5, 2008

These and other articles of the author can be accessed at the website
www.professorfekete.com

Note: the author is coming out with a follow-up piece:
Has the Curtain Fallen on the Last Contango in Washington?

Gold Backwardation Resulting Gold Fever

Commodities / Gold & Silver Dec 10, 2008 - 02:54 PM

By: Professor_Emeritus

Here is an update on the backwardation in gold that started on December 2 at an annualized discount rate of 1.98% and 0.14% to spot in the December and February contracts. It continued and worsened on December 8, 9, and 10 as shown by the corresponding rates widening to 3.5% and 0.65%. It is nothing short of awesome. This is a premonition of a coming gold fever of unprecedented dimensions that will overwhelm the world as soon as its significance is fully digested by the doubting Thomases.

The worsening of backwardation must be viewed in the context of the gold price bouncing back from the lows of last week. It shows that the 'gold bashing' on Friday was done in the December contract. It is quite revealing that the spot price bounced back more than the futures price . The bulls are on the warpath. They have unearthed the hatchet. They have stopped eating from the hands of the clearing members.

Mish Shedlock published a disdainful criticism of my theory on the worsening backwardation in gold, calling it "nonsense" (see References below). A friend of his owns a seat on Nymex (a branch of Comex) who had this to say:

I have seen countless commodities go into backwardation for numerous reasons, the most frequent being a radical temporary divergence between immediate and overall demand. I have seen backwardations that have lasted years. The article is based on the assumption that a backwardation will necessarily lead to a breakdown of the delivery mechanism. But for every breakdown of the delivery mechanism there have been thousands of backwardations without a breakdown. Only if and when an actual breakdown occurred would the conclusions that the author drew make sense.

Well, well, one can buy himself a seat on the Nymex for sure, and the price is hefty these days, but Nymex does not deliver the understanding of monetary science along with the seat. Nor does any university anywhere in the world. To fill this obvious gap, I founded Gold Standard University Live. It is defunct today, but not because my theories are "nonsensical".

It is defunct because Mr. Eric Sprott of Sprott Asset Management withdrew his funding after only three sessions, saying that "results do not justify the expense". Under these circumstances I do what I can to teach all those who want to learn, and pick the "forbidden fruits" of monetary science that have been blotted out from the curriculum -- and from the gold and silver pits of Nymex.

Mish says that "there is nothing special about backwardation, period. OK, they are rare in gold. So what?" Here is what. There is a difference between "rare" and "non-existent". Backwardation in gold has been non-existent, and for a very good reason, too, as I have explained in my articles. (I also pointed out that there have been 'hiccups', or short-lived instances of backwardation. They were temporary 'logistical' bumps, always resolved within a day at most, and they never ever spilled over to the next actively traded delivery month.)

Mish needs to educate himself on the fundamental difference between a monetary and a non-monetary commodity, before he can grasp the idea that lasting backwardation in gold is tantamount to the realization that 'gold is no longer for sale at any price'.

The bottom line is that there is no fever like gold fever . It is akin to St. Vitus' dance that swept through the Christian world just before the year 1000 A.D. affecting all the people who expected the end of the world to happen at the turn of the millennium. It was far worse than the mania that swept through the world affecting all the people who expected the 2K disaster to happen a thousand years later. The coming gold fever must be distinguished from tulipomania in February 1637, when one single tulip fetched the equivalent of 20 times the annual income of a skilled worker. Gold fever is as different from a bubble as real gold is from fools' gold. It is visceral. It has to do with one's instinct for survival. It has no patience with logical arguments. It is highly contagious, ultimately affecting everybody. A bubble that never pops.

You may ridicule the idea that, during a prolonged backwardation, all offers to sell gold will be withdrawn. But a serious analyst must answer the question why hundreds of millions of people having gold coins under the mattress and in the cookie jar refuse to take the bait of 'risk-free' profits offered by backwardation. Such a thing would never ever happen to a non-monetary commodity.

The only successful corners in history were gold corners, a.k.a. hyperinflation. Keynesian and Friedmaite economists in the pay of the government thought that gold futures trading will permanently short-circuit the forces of gold backwardation thus preventing hyper-inflation from ever happening. They were wrong.

In an article The Manipulation of Gold Prices (see References below), Professor Emeritus of Economics and former Dean of the School of Business Administration at the University of Indianapolis, James Conrad argues that Bernanke is different. He understands that he needs a much higher gold price in order to increase the efficiency of his airdrops. There is no better way to distribute new money among prospective spenders than putting it into the pockets of the gold bugs. (Conrad admits that he is one.) This will induce a large spending spree, holding deflationary pressures back.

According to Conrad, Bernanke is well aware that the new money he is feverishly airdropping has not stopped and will probably not stop the bloodbath in the stock market. Further devastation of share prices will render pension funds insolvent. To prevent this, the dollar needs a massive devaluation, on the pattern of Roosevelt's tinkering with the value of gold. I quote:

Anyone who reads the written works of our Fed Chairman will know that Bernanke's long term plan involves devaluing the dollar against gold. This is the exact opposite of the position of most prior chairmen. He has overtly stated his intentions toward gold, many times, in various articles, speeches and treatises written before he became Fed Chairman. He often extols the virtues of F. D. Roosevelt's gold revaluation/dollar devaluation back in 1934, and credits it with saving the nation from the Great Depression. According to Bernanke, devaluation of the dollar against gold was so effective in stimulating economic activity that the stock market rose sharply in 1934, immediately thereafter. That is something that the Fed wants to see happen again.

It is only a matter of time before gold is allowed to rise to its natural level. Assuming that about one half of the recent increase in Federal Reserve credit is neutralized, the monetized value of gold should be allowed to rise to between $7,500 and $9,000 per ounce as the world goes back to some type of a gold standard. In the nearer term, gold will rise to about $2,000 per ounce as the Fed abandons its hopeless campaign to support Comex short sellers in favor of saving the other, more productive, functions of various banks and insurers.

Revaluation of gold, and a return to a gold standard, is the only way that hyperinflation can be avoided while large numbers of paper currency units are released into the economy. This is because most of the rise in prices can be filtered into gold. As the asset value of gold rises, it will soak up excess dollars, euros, pounds, etc., while the appearance of an increased number of currency units will stimulate investor psychology; and lending and economic output will increase all over the world. Ben Bernanke and the other members of the FOMC Committee must know this, because it is basic economics.

It is to be regretted that more of Professor Conrad's admirable paper cannot be quoted here because of lack of space. To summarize: Bernanke is prepared to throw the issuers of paper gold at the Comex to the wolves, as they have become useless, even a nuisance, by now. Besides, the wolves must be appeased lest they devour whatever remains of the U.S. banking and insurance system.

My own position is somewhat different from Professor Conrad's. In my view we are facing a world-wide elemental grass-root movement: the flight into physical gold -- witness the backwardation in gold. It is irresistible, and will ultimately overtake all other market forces. It will overwhelm official resistance.

An intriguing case can be made, as is attempted by Conrad, that Bernanke is intelligent enough to realize all this thinking that he can harness, if not hijack, the grass-root movement for his own purposes. This is a wee-bit more intelligence than I can give credit for to the Chairman, who is a former academic himself. I find the thought surrealistic that Bernanke wants to use gold as the safety-valve through which he can release steam from an overheating deflation one day, and from an overheating inflation the next.

Be that as it may, the Brave New World of irredeemable currency sans the paper gold factory at Comex will be an entirely different world from what we have been used to for the past thirty-six years. I highlight the differences as I see them. This should be helpful in the long run, even if this backwardation is temporary and gold futures trading will return to normal, since permanent backwardation is ultimately unavoidable.

Item 1 : Barrick and other gold producers that still have an open hedge book will go bankrupt.

Item 2 : Other gold miners will, one after another, stop selling gold altogether, and go into hibernation.

Item 3 : Junior gold mines will put off starting production indefinitely. They will consider their gold ore reserves in the ground a safer store of value than paper money in an insolvent bank.

Item 4 : The closing of the gold window at the Comex will furnish an excuse for other issuers of paper gold including the bullion banks to declare bankruptcy fraudulently.

Item 5 : GLD and other joint depositories of gold will be under enormous pressure to default and let the owners of the ETF shares hold the bag. Let them sue for the gold. They won't get it: their contracts give them no right to physical gold. They will get small change, in paper . The principals will cut up the gold pie among themselves. No crumbs will trickle down to shareholders.

Item 6 : Even allocated and segregated metal account gold is not safe. The temptation on the account providers to default will be irresistible. They are not going to release the gold until expressly ordered by the courts, and will make sure that no gold will be left by then.

Item 7 : Central banks forfeit their gold under leases due to backwardation, causing an uproar of citizens whose patrimony was sequestered and dissipated in such an ignominious manner.

Item 8 : The only market for gold will be the fragmented black markets in various countries each charging a price whatever the traffic can bear. All legal protection of the ownership of and trade in gold will be suspended. The Dark Age will descend on the trading world, just as it did when the Roman Empire collapsed.

Our present experiment with irredeemable currency can last only as long as it is able to support futures markets in gold. The declining gold basis is the hour glass: when it runs out and the last grain of sand drops, gold fever will bleed the futures markets of cash gold, and the days of the regime of irredeemable currency are numbered.

Previous episodes of experimentation lasted no more than 18 years, or half as long as the present one which has taken 36 years so far, a world record. Of course, none of the earlier episodes were supported by futures markets. Forewarned, forearmed. Get ready and move closer to the doors. When the curtain falls on the last contango in Washington, there will be panic and some people may get trampled to death at the exit.

Dear Mish, lower your gun. The topic of gold backwardation is not for you.

References

The Last Contango in Washington , June 30, 2006
Red Alert: Gold Backwardation! December 4, 2008

This and other articles of the author can be accessed at the website www.professorfekete.com

Note: the author is writing a follow-up piece: There's No Fever Like Gold Fever
Stay tuned.

Calendar of events

Szombathely, Martineum Academy, Hungary, March 28-29, 2009
Encore Session of Gold Standard University Live.

Topics: When Will the Gold Standard Be Released from Quarantine?
The Vaporization of the Derivatives Tower
Labor and the Unfolding Great Depression
Gold and Silver in Backwardation: What Does It All Mean?

San Francisco School of Economics, June-August, 2009
Money and Banking , a ten-week course based on the work of Professor Fekete.

TheSyllabus of this course is can be seen on the website: www.professorfekete.com

By Professor Antal E. Fekete,
Intermountain Institute for Science and Applied Mathematics

"GOLD STANDARD UNIVERSITY" - Antal E. Fekete [email protected]

For further information please check www.professorfekete.com or inquire at [email protected] .

We are pleased to announce that a new website www.professorfekete.com is now available. It contains e-books, archives, news about GSUL, and material of current interest

Copyright © 2008 Professor Antal E. Fekete
Professor Antal E. Fekete was born and educated in Hungary. He immigrated to Canada in 1956. In addition to teaching in Canada, he worked in the Washington DC office of Congressman W. E. Dannemeyer for five years on monetary and fiscal reform till 1990. He taught as visiting professor of economics at the Francisco Marroquin University in Guatemala City in 1996. Since 2001 he has been consulting professor at Sapientia University, Cluj-Napoca, Romania. In 1996 Professor Fekete won the first prize in the International Currency Essay contest sponsored by Bank Lips Ltd. of Switzerland. He also runs the Gold Standard University on this website.

DISCLAIMER AND CONFLICTS - THE PUBLICATION OF THIS LETTER IS FOR YOUR INFORMATION AND AMUSEMENT ONLY. THE AUTHOR IS NOT SOLICITING ANY ACTION BASED UPON IT, NOR IS HE SUGGESTING THAT IT REPRESENTS, UNDER ANY CIRCUMSTANCES, A RECOMMENDATION TO BUY OR SELL ANY SECURITY. THE CONTENT OF THIS LETTER IS DERIVED FROM INFORMATION AND SOURCES BELIEVED TO BE RELIABLE, BUT THE AUTHOR MAKES NO REPRESENTATION THAT IT IS COMPLETE OR ERROR-FREE, AND IT SHOULD NOT BE RELIED UPON AS SUCH. IT IS TO BE TAKEN AS THE AUTHORS OPINION AS SHAPED BY HIS EXPERIENCE, RATHER THAN A STATEMENT OF FACTS. THE AUTHOR MAY HAVE INVESTMENT POSITIONS, LONG OR SHORT, IN ANY SECURITIES MENTIONED, WHICH MAY BE CHANGED AT ANY TIME FOR ANY REASON.

Antal E. Fekete / Professor_Emeritus Archive

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Gold, silver prices rally. Silver stocks show strong gains

Gold Backwardation Resulting Gold Fever

Commodities / Gold & Silver Dec 10, 2008 - 02:54 PM