Dec 2, 2008... the death of the COMEX, and the death of the dollar

Safe Haven ^ | 12/05/2008 | Antal Fekete

[slnk_rules]

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.

[slnk_rules]

Contango in the PMs is dead. For those of you who don't follow futures mkts, this means the following: It is normal for the future delivery price (the futures price) to trade at a premium to the current contract price (spot price) in any given commodity. In fact, there is a whole mini-industry in the futures markets who are on the lookout for when the "carry" price (spot plus the interest rate for the amount required to "carry" the delivered commodity) gets high enough to make it profitable to sell the futures and simply deliver. When the opposite is true (called "backwardation") it creates another opportunity for a sure profit. You sell the physical and buy the futures at a discount, thus locking in a profit. That is why in an HONEST market, a backwardation situation won't exist......, like it does now. This is, by the way one of the good reasons for a futures market in the first place. Arbs (arbitrageurs) are ever vigilant to spot price discrepancies in markets and pile into them until the anomalies correct themselves. You can, by the way arb a synthetic contango or synthetic bacwardation with a combination of options. This is called selling against the box, and is much more common. Even as I type this I am thinking of a dozen different reasons that these an simplifications of the issue, so don't rip it apart. This is not a manual on trading strategies, ok?

Backwardations are rare, because they are invitations to arbs, and no one gives away a sure profit. Sometimes you will see them open up at option expiration, but the same people who are on the lookout for them tend to be vigilant about this time and are ready to pounce on them. My own small firm traded almost exclusively arbs against contangos and backwardations in the currencies on option expiration days back when the dmark was moving around during the Gulf War I. Practically the only trades we did were on OE days. We would look for the Interbank physicals to get out of line with one month out option premiums and do rather large (large for us!) trades, then do an EFP (exchange for physicals) trade on the MERC. Huge positions were being unwound, so if you were fast you had the ability to make some decent money.

The situation now is that of a fairly healthy backwardation in gold and an even heavier one in silver. So why are people not selling the spot, buying the DISCOUNTED futures, and locking in a sure profit? It is a made to order situation for arbs. The reason is simple. The comex has been notified that almost 40 PER CENT of its stated gold reserves are going to be called! Assuming that the COMEX has all the gold it says it has (a big big assumption in my book!), FORTY PER CENT of that is for all intents and purposes, gone. The holders of long contracts have notified that they intend to ask for delivery. Now how many of those will show up in trucks and MOVE the gold is another question, but they have the legal right to do so if they wish. The silver situation is both slightly worse and horrifically worse. It is slightly worse in that the percentage is just short of 50 per cent. It is horrifically worse in that the silver market is tiny, even compared to gold. Both of them together are like a gnat fart compared to say, Tbills or eurodollars or US 10 year bonds. The fact is that we have a short squeeze going on and it is PUBLICLY led, not run by the Hunt Brothers. The reason the backwardations arb is not happening is that NO ONE WANTS TO CUT LOOSE OF THEIR PHYSICAL METAL BECAUSE THEY DON'T TRUST THE FUTURES CONTRACTS TO BE DELIVERABLE. You have to realize, these are not some irrelevant nothings like yours truly who are passing on the arbs. These are huge IB entities like Suisse Bank, Goldman, Bank of Japan, Sumitomo, the government of Malaysia, and other big big arb players in the past. They have their hands in their pockets just staring at the numbers, which are BEGGING them to sell physicals, buy the futures and lock in a profit. Why? There is only one possible answer. They know the COMEX is facing default.

If the COMEX fails to deliver, citing force majeure or simply calling out the clause in the futures contracts that allows them to settle in cash rather than cough up the PMs themselves, you could easily see a 100% run in the price of gold and silver.

But the correllary is much more sinister. If the arbs are turning away from a certain dollar profit, it means that the dollar is losing confidence as a medium of exchange. There simply is no other way to spin it. The ONLY thing that has kept the dollar afloat since 1973 has been the confidence in the world's financial marketplaces that it is a safe and reliable medium of exchange. Once that confidence goes, the end of the dollar will be quick, brutal, and horribly ugly.

I would say buy the physical metals while you can. Mock me in 2-3 years if you want to, but I don't think you will.

[slnk_rules]

ping

[rellimpank]

—bflr—

[thinking]

Why am I not surprised.....

[Travis McGee]

Great post, thanks!

[null and void]

Worth repeating:

But the correllary is much more sinister. If the arbs are turning away from a certain dollar profit, it means that the dollar is losing confidence as a medium of exchange.

I've been saying for decades that I'm confident that I'll get back every penny that I put into Social Security. A McDonald's burger may cost $3000, but I'll get back every penny...

[nicola_tesla]

Or it means that the folks you mention, Goldman, Credit Suisse, BOJ, China Development etc etc are all still deleveraging and know they will have to sell their gold to stay alive in this market as they unwind their leverage.

Heck, back in the summer what was the hedge fund favored trade pair - long oil and short gold, right ? What a shock that we now see the reverse - short oil and long gold.

I don’t think it’s any more complicated than that.

In a deflationary depression, the price of gold and silver is just that of another commodity, and they will be treated the same way. There’s not one currency on the gold standard anymore.

[Admin Moderator]

In the future, note the Activism sidebar is reserved for News/Activism of the FR chapters and not this.

[slnk_rules]

sorry about that. it was an honest mistake

[SAJ]

Where the hell's the backwardation?

Silver, close 2008-12-05

                 Settle   chg   open  high  low   prev 
Dec '08 (SIZ08) 9.401s  -0.090 9.400 9.525 9.135 9.491
Jan '09 (SIF09) 9.401s  -0.090 9.420 9.495 9.180 9.491
Feb '09 (SIG09) 9.416s  -0.090 9.215 9.440 9.215 9.506
Mar '09 (SIH09) 9.430s  -0.090 9.500 9.560 9.125 9.520
May '09 (SIK09) 9.445s  -0.092 9.450 9.520 9.250 9.537
Jul '09 (SIN09) 9.459s  -0.093 9.290 9.459 9.290 9.552
Sep '09 (SIU09) 9.470s  -0.093 9.560 9.560 9.470 9.563
Dec '09 (SIZ09) 9.488s  -0.095 9.450 9.488 9.230 9.583
Jan '10 (SIF10) 9.494s  -0.095 9.494 9.494 9.494 9.589
Mar '10 (SIH10) 9.506s  -0.095 9.506 9.506 9.506 9.601
May '10 (SIK10) 9.516s  -0.095 9.516 9.516 9.516 9.611
Jul '10 (SIN10) 9.525s  -0.096 9.525 9.525 9.525 9.621
Sep '10 (SIU10) 9.533s  -0.096 9.533 9.533 9.533 9.629
Dec '10 (SIZ10) 9.545s  -0.096 9.350 9.545 9.350 9.641

Gold, close 2008-12-05

Dec '08 (GCZ08) 750.5s  -13.3 764.5 769.6 740.0 763.8
Jan '09 (GCF09) 750.9s  -13.3 769.9 769.9 741.1 764.2
Feb '09 (GCG09) 752.2s  -13.3 766.7 773.3 741.2 765.5
Apr '09 (GCJ09) 753.7s  -13.2 768.7 774.1 743.5 766.9
Jun '09 (GCM09) 755.2s  -13.2 773.7 774.0 748.0 768.4
Aug '09 (GCQ09) 756.8s  -13.2 772.8 773.0 756.8 770.0
Oct '09 (GCV09) 758.7s  -13.1 758.7 758.7 758.7 771.8
Dec '09 (GCZ09) 760.8s  -13.0 779.5 779.5 750.0 773.8
Feb '10 (GCG10) 762.8s  -13.0 762.3 762.8 762.3 775.8
Apr '10 (GCJ10) 764.8s  -13.0 764.8 764.8 764.8 777.8
Jun '10 (GCM10) 766.9s  -13.0 766.9 766.9 766.9 779.9
Aug '10 (GCQ10) 769.2s  -13.0 769.2 769.2 769.2 782.2
Oct '10 (GCV10) 771.6s  -13.0 771.6 771.6 771.6 784.6
Dec '10 (GCZ10) 774.0s  -13.0 793.6 810.9 764.4 787.0

OK, so front month is very close to 2nd month? Big deal, this happens lots of times when front month gets close to expiration. The contango **is** shrinking in silver, so what? Not surprising, interest rates (part of the cost of carry) are going through the floor.

Your comments about backwardation are bizarre (with the exception of your remarks about the sell-and-deliver arb). You're an old wheat trader -- you know perfectly well when mkts become inverted, f'Heaven's sake: when immediate demand exceeds immediate supply.

They ain't there yet. Show me a $3-4 dollar m/m inversion in GC, and I'll start considering your point. Until then, this stuff belongs in World Weekly News.

Sorry, m'friend, FReegards anyhow.

[Leisler]

Anything we are doing, and we are, as Socialist, central planning is universal( funny how the elites everywhere like concentrated power. Of course, its for the children. THEIR children, anyways..)

Watch England, and others. Everyone is under the stress of lifting delusions.

Another thing, there is not enough gold, in the entire world, to even work as a trade unit for just the US economy.

If, say, gold is the only medium of exchange, then look for a world economy of about 1 percent of preset size.

Frankly, I say if world GDP falls 10 percent, then you will have political and physical chaos, world wide. Enough so that 200 foot ex Saudi Costguard Cutters will be collecting ‘transit taxes, in cash, even depreciated cash’ off the Arabian coast. No truck, train, or plane will land or take off near any third and quite a few 2nd world ports.

Demagogues will haunt the streets of European Capitals.
Detroit, Chicago will be in the sway of Louis Farrakhan.

Not much will come out of Africa but high value items and refugees, by the tens if not hundred millions. No wheat, foodstuffs, bulky and too expensive to pay bribes and ship on trucks on decayed roads, or busted railroad tracks into the interior.

American and European youth, the few that there are, will volunteer to die, suffer for third world gaping mouths. And no politician or present institution has the ethical or moral authority to inspire or command. Elites world wide are held in contempt by the mass of people, and rightly so.

Anyways, you may have your gold. But you may not have enough to buy anti-biotics, or foodstuffs.

If you are that worried, think a rural farm and guns.

[montag813]

This is nonsense. Gold futures have tanked along with commoities, because global hedge funds continue to liquidate long positions to satisfy redemptions. Every time gold futures have spiked in the past 3 months, it has been followed by huge selling on volume.

[dennisw]

Thanks for posting.
If you really like gold then your core holding should be physical and go have fun speculating on gold ETFS, futures etc

Gold bullion coins are more available and the mark up over spot gold has gone down from 6 weeks ago. THUS physical is selling at less of a premium over paper gold like COMEX

http://www.apmex.com/Category/21/Gold_Canadian_Maple_Leafs_2009__Prior.aspx

Same company had American Eagles at a lower mark up a few days ago.... gone now

[slnk_rules]

Or it means that the folks you mention, Goldman, Credit Suisse, BOJ, China Development etc etc are all still deleveraging and know they will have to sell their gold to stay alive in this market as they unwind their leverage

.it is true that a radical deflationary environment would bring backwardation pressure. However, the point at issue is that the arbs will ALWAYS step into the gap for the short term locked in profit......, if they can find someone to lend them the gold. As you are aware, there is an active leasing market for gold as there is for all commodities, and a more extensive one for gold and silver because of their monetary use. So, what is keeping me from BORROWING the gold (leasing it), selling it, and buying the discounted futures? Easy 3% return, right? Only if you have confidence you will be able to get your gold back that you sold. Look at the leasing rates for gold. Look at the amounts leased. Why is no one running into the gaps here?

It looks an awful lot like a confidence thing to me.

Thank you for your reply, though. The longer I am in the markets the more convinced I am that I don't know a thing.

[ggekko60506]

Completely plausible and massively sobering.

[bereanway]

Didn’t nickel at the LME go into default a couple years back? I thought those who had to deliver were penalized a small amount and allowed to deliver at a later date but I could be wrong.

Back around July 13 a couple large banks (it sounds like JPM and possibly HSBC) began to crash the COMEX silver and gold futures markets and force the margined longs to liquidate. Possibly one and no more than two banks sold 33,805 silver contracts w/o purchasing one offsetting long. Totaled 1/4 of annual silver production being dumped in a short time frame, they did the same with gold although the relative #’s weren’t quite as large. Supposidly the CFTC’s enforcement division is investigating but I wouldn’t hold my breath. Somebody owes the Hunts an apology.

The COMEX has been used for some time to lead the physical market by the nose but it sounds like the day of reckoning may be approaching. When this thing breaks it will be violent and will be interesting to see what the powers that be do to control the PM’s to seal the financial exits from the dollar.

[dennisw]

40 PER CENT of its stated gold reserves are going to be called! Assuming that the COMEX has all the gold it says it has (a big big assumption in my book!), FORTY PER CENT of that is for all intents and purposes, gone. The holders of long contracts have notified that they intend to ask for delivery. Now how many of those will show up in trucks and MOVE the gold is another question, but they have the legal right to do so if they wish. The silver situation is both slightly worse and horrifically worse. It is slightly worse in that the percentage is just short of 50 per cent.

James Sinclair has been egging people on for weeks to take delivery and bust the paper gold market open. He even gave out detailed information on who was reliable to take physical delivery and have it shipped to a free trade zone warehouse in Switzerland. I don't have the money to do this. But buying gold and holding it outside the USA is the way to go to guard against confiscation by commies like Obama

[jsh3180]

Here are some comments from Dan Norcini, a commodity trader and gold bug about Antal Feteke’s (sp) article that you refer to. Norcini has daily commentary at Jim Sinclair’s JSMineset.com. Norcini does not seem to think this backwardization is a big deal, YET. Anyway, he’s a gold bug, I’m a gold bug, I’m certainly fairly convinced of market manipulations in gold and silver....enough of that...here’s Dan (Trader Dan) Norcini’s comments:

Many of you have been sending me links to a recent essay from a man whom I greatly respect and consider a friend, Professor Antal Fekete. His piece was dealing with the gold basis. In it he mentioned that backwardation had occurred for a 48 hour period in which spot gold was trading at a premium to the Comex gold futures market, something which we refer to as backwardation.

I want to offer a few comments on his article as a way to answer the many emails I am receiving on this. It will allow me to post one reply instead of vainly attempting to answer so many individual emails that are rapidly threatening to overwhelm me.

First of all, I prefer to use the term backwardation to refer not so much to a negative basis as Antal defines it, but rather to the structure of the particular futures market that is concerned. I do agree with Antal’s use of the terms, “negative and positive basis”. This is really not an attempt to split hairs for me but simply a use of the terms in such a manner that I have learned to use them as a trader.

The normal structure of the majority of futures markets, a few are excepted, is one in which the nearer contracts trade at a discount to the distant month contracts. The reason for the higher price in the distant months is that those prices include the cost of storing the commodity or warehousing it, plus the insurance needed to cover the stored commodity in the event of theft, fire, etc and interest costs. Under normal conditions, the price of those distant commodities converges with the cash price as the time for delivery draws near. That makes sense since if you are no longer storing the stuff, you no longer need to pay for the warehousing nor do you need to insure it, etc.

In backwardation, the front or “nearer” contracts trade at a premium to the distant month contracts. Markets that go into backwardation are markets that are marked by exceptionally strong demand for that particular commodity or exceptionally low supply at current prices. What the market is attempting to do is as Antal states in his piece – that is, to draw out sufficient supply from potential sellers to meet the current levels of demand. If I cannot get you to sell me your scarce apples at $0.25 each, I raise my bid to $0.30. I might be able to make you a bit more willing. If that still did not do the trick, I would have to raise my bid even higher to perhaps $0.35 each in order to entice you to sell that same apple. If you look at the board for “Apple Futures” and see that apples for delivery in June of next year are going for $0.30 but you can sell them now for $0.35, chances are that you will sell those apples to me instead of waiting 6 months, during which anything might happen in the world of apples!

An example of a market that went into backwardation occurred back in the Minneapolis wheat market not all that long ago in which traders bid the price of the front month contract to a never-before-seen price of nearly $25 bushel for wheat! To give you an idea how extreme that was, wheat generally sells for anywhere from $3.50 - $5.50 or so. The market was telling sellers that it wanted hard spring wheat at any price and was willing to pay that price as long as the wheat was delivered RIGHT NOW.

Now as far as backwardation as I define it goes (a structure in the futures market in which the front month gold contract trades at a premium to the distant months), gold is not there yet.

I am linking below a few spread charts that compare the December gold contract to both the April 09 and the June 09 contracts to show you that December is still trading at a discount to both April and June with the notable point that its spread has indeed narrowed. While technically this is not backwardation as I understand the concept, it is a narrowing or a move in that direction and that is something definitely worth paying attention to.

Now let’s go to the term “basis”. That is the difference between the futures market price of a commodity and the spot market or cash price of that same commodity. Antal mentions that gold has exhibited a negative basis, one in which the futures market price is lower than the cash or spot market price. That is, as he points out, very unusual as it would seem to indicate a tightness in the physical market brought about by would-be sellers not willing to part with their gold. Again, Antal is absolutely correct – if spot gold is trading at $750 and the futures market is trading at $745, that is a $5.00 per ounce risk free profit just sitting there waiting for a type of arbitrage. One could immediately sell his physical gold at the $750 price and immediately buy it at $745 in the futures market with the intent of taking delivery to meet his contractual obligations and pocket $5.00 ounce for however many ounces one wished. Buy 5 million ounces of gold at $745 and sell that same amount of gold for $750 and you have gotten yourself a cool $25 million profit less the delivery expenses, etc. Not bad. That is why such a thing does not occur very often nor does it last for long. Too many would jump on the chance for a no-risk trade of such nature. Why then are they not doing so? Antal has answered that question – they are not willing to part with their gold for paper profits! That is what makes this development so noteworthy.

The key is whether or not this sort of thing continues for long so we will definitely have to monitor it.

One thing I wish to add however – trying to construct a gold basis chart is a bit difficult to do. One of the reasons is because the basis, which as Antal correctly defines as the difference between the front month futures contract and the cash or spot price, must be defined at the exact same moment in time due to the wicked volatility of the futures market. The gold futures market generally is moving much faster than the spot price of gold. To get an accurate reading of the gold basis then is very difficult at times due to the lag. Some of you might have noticed this when you have been recently making purchases of gold and are getting a spot price off of a web site such as Kitco and looking at the futures market price. You can see the difference. Sometimes, by the time you get to making that phone call to place your order thinking you have gotten a deal, you are informed that the spot market price of gold has “caught up” to where it was trading on the futures.

In the grain markets we can generally use the price being quoted at one of the elevators and compare that to the futures market price to determine the basis. Same goes for the livestock, etc. In gold however, we have to use the spot market price at any given moment so for a basis chart to be accurate, in my opinion, it must give the spot market price of gold and the futures market price of gold at the exact same hour of the day. For example, one could take the London PM fix done at 9:00 CST, and take the hourly price of gold on the Comex front month contract and compare the two prices. That would give you an accurate basis chart.

If anyone out there actually has some basis charts for gold, I would be interested in knowing how they were constructed. What time did they use to make the comparison?

I can give you a brief basis chart using the last week and the December futures contract at 9:00 AM CST and comparing that to the London PM Fix so that you can see the basis. It is indeed negative in some instances as Antal has mentioned.

In closing let me just state how grateful I am for Antal’s excellent essay and for his innumerable talents which he brings to bear for the benefit of those who love honest money! I was not fortunate enough to have been able to sit in on his classroom series but I have no doubt whatsoever that those that did came away with a wealth of knowledge.

[erman]

I've been saying for decades that I'm confident that I'll get back every penny that I put into Social Security. A McDonald's burger may cost $3000, but I'll get back every penny...

I have said the same thing. Sure I'll get 200 dollars a month.... but I can buy a pack of gum with two months of my social security checks. The ONLY way the government is going to get out of the Ponzi scheme social security lie is to inflate it's way out of trouble and let the inflation "correction" be less... then means test the "rich" and the idiots that think they'll live off of social security can look like their brethren paupers in the old Soviet Union and Eastern Europe... living like huddled old peasants in the city but worshiping the government nipple for their scraps.

then of course they can raise taxes to "help out the poor old folk"... bookmark this..save it on your hard drives so that the government will not put this down the memory hole... DEMOCRATS want the country to be bankrupt in order to control the people. Every northeast city, Michigan, Chicago, California and every other place the democrats have controlled have turn to sh#t, but they still keep trying to TAX their way to prosperity. Cause this time they really really really really have a "good program" to "grow the economy" or "create jobs"... government doesn't create jobs, it controls job markets and delegates the winners and losers.

The funniest thing is that people that went into politics couldn't "DO" anything for a living except spout off on how smart they are and how they need to "lead" us.

My advice to my kids, live below your means. Be the hardest worker and obtain skills that are valuable... medicine, building, engineering, nursing etc... and above all trust only God and your family.

[slnk_rules]

I don’t understand. Spot gold Friday afternoon was trading 15 PREMIUM to next mos futures. This is a classical arb situation. Ditto for silver. It is trading 13 cents premium to the futures. You also have a suppression of the basis in the back months relative to the front end, which as you know, is a classic spread invite.

I have a great deal of respect for you SAJ. You clearly know a great deal more about the markets and the intricacies of finance than me. My remark to some guy who asked me what the spring planting numbers were was “what’s a ‘spring planting?’ the bid is a quarter, offer the gutters, nickel off the hi of the day and we are long term bullish. As far as anything else goes, we could be trading hubcaps down here and I would not know the difference.”

I would appreciate understanding how you don’t see this in an invitation to arb, and why that is not being exploited?

Thanks in advance