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Silver Trending Towards Backwardation Again

by Trace Mayer, J.D. on September 12, 2009 · 13 comments

Reading time: 5 – 8 minutes

The silver backwardation has been on-again off-again throughout 2009 and this portends gigantic problems for the worldwide monetary system.  Backwardation is a situation where the fiat currency price of a commodity is pregnant with a premium the buyer is willing to pay for immediate delivery.  The price of a commodity for future deliver is lower than the spot price.  This is contrasted with contango where the spot price is lower than the futures price.  Backwardation seldom arises in the monetary commodity gold or the quasi-monetary commodity silver.

QUESTIONS

The depth of one’s intellect can usually be answered by the questions one asks.  In our family we have a couple jokes.  For example, ‘How big is yellow?’  And, ‘How many kids with ADD does it take to screw in a light bulb?  Wanna go ride bikes?’

As my articles are widely syndicated throughout the Internet it is interesting to see the comments they receive.  I really wish I had the time to read them all and respond, which I do occasionally, but there are more important things to do.  But in preparing this article I decided to review some of the comments from my earlier articles and found it quite humorous.

For example, on 25 Feburary 2009 Cesato remarked, “In my experience backwardation has sooner or later led to a price collapse in any commodity. I’ve never been a long term buyer when a commodity is in backwardation”.  On 25 February 2009 silver closed at $13.81 and by 11 September 2009 the backwardation had ended and silver closed at $16.77, a 21.4% gain or a 39.5% annualized rate when measured with the undefinable dollar.

On my article ‘How the Treasury Bubble Will Burst and Why‘ at Seeking Alpha I received a comment from Alan Brochstein, CFA and fellow Seeking Alpha Gold Standard Contributor who provides analytical services for hire. He said, “Trace, sorry, but this makes absolutely no sense…” This is not surprising considering his 8 Dec 2008 article ‘Own Gold? Time to Fold‘ where he stated, “Gold remains a sucker’s bet…”  On 8 December 2008 gold closed at $772.25 and by 11 September 2009 gold closed at $1,005.70, a 30.2% gain or a 39.8% annualized rate.

In February 2009 after I observed about two week’s worth of silver backwardation I then proceeded to ask and answer this question:

What if silver trades in backwardation for an extended period? Well, I already answered this question earlier.  It means individuals are unwilling to take the risk of holding national currency illusions or the risk of an exchange’s failure to deliver.  Potentially the national currency illusions could be pulled into the event horizon leading to the fiat currency graveyard.

The fundamental outlook for the FRN$ has gotten even worse, although there is a case for the FRN$ to rise, and the potential for a COMEX gold or silver delivery failure is a constant specter.

BACKWARDATION SPECTER RISING

The specter of backwardation is rising.  The COMEX contracts for Sep 2009 and Oct 2009 had the same settlement price.

Likewise the London SIFO, the Silver Forward Mid Rates, have been trending towards backwardation.

Additionally, the LIBOR-SIFO is moving toward dangerous territory.

While silver has not settled into backwardation yet this will be an important trend to watch.  Having the physical metal in one’s possession or with a trusted third party like GoldMoney gaining in importance.  I would be particularly wary of unallocated gold or silver accounts.  Usually silver is a very quiet metal.  But when it moves, it moves!  About 90% of silver’s price movement happens in 10% of the time.

SILVER IS RELATIVELY CHEAP

SILVER INVESTING GUIDES

For those that are new to the silver market and are considering how to buy silver an excellent book is from Mr. David Morgan of Silver-Investor called Get The Skinny On Silver Investing or Mr. Michael Maloney’s Guide To Investing In Gold And Silver.

CONCLUSION

At all times and in all circumstances gold, silver and platinum remain money.  The silver market is miniscule compared to the amount of total tangible and financial assets in the world.  Yet silver can never become worthless because it is a tangible asset.  As capital continues seeking a safe and liquid home silver is among the beneficiaries.  With the Chinese and Indian acquisition of physical silver there will be even more strain on the paper markets for delivery.  While silver is currently not as cheap as it was earlier when I recommended buying; the ‘tears of the moon’ is still a decent value.

DISCLOSURES:  Long physical gold, silver and platinum with no position in the problematic GLD or SLV ETFs.

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13 comments

ABOUT THE AUTHOR: Trace Mayer, J.D., author of The Great Credit Contraction holds a degree in Accounting, a law degree and studies the Austrian school of economics. He works as an entrepreneur, investor, journalist and monetary scientist. Follow him on Twitter. This is merely one article of 241 by .
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{ 10 comments… read them below or add one }

1 tony bonn September 12, 2009 at 6:27 pm

it would be very difficult to talk too much about backwardation especially of gold….as we edge closer to that condition again we can be certain that the paper regimes are teetering…

speaking of imbecile economists and financial advisers, there is a whole bumper crop over at zerohedge who gave the same ho-hum advice about gold and complete indifference to backwardation……

antal fekete is the high priest of the gold basis and is worth studying…..we live in very interesting times to put it mildly…..we are the first generation in living memory to see silver and gold backwardation…..it is truly unprecedented……

buy gold early and often….

2 Barry Schatz September 13, 2009 at 7:57 am

Please date your articles! And put the date at the top. Discussing market phenomena without divulging on which date you speak is disorienting for the reader.

3 dojufitz September 14, 2009 at 11:10 pm

I’m been buying both Silver and Gold since march 2008.

All these terrible things are all coming to a head and i feel once the Fed is audited – look OUT!

Buying Silver at this point in time would have to be a once in a 1000 year opportunity that almost no one is seeing – the lucky few have the foresight.

There are 3 types of people in the world.

The type that makes things happen.
The type that watches things happen.
And finally the type that says ‘What just happened’?

Good luck.

4 John Q Public September 15, 2009 at 6:01 pm

Who is going to buy this over-priced gold at $1000+ and silver at $20+ per ounce? There are people losing jobs, stores are selling laptop computers for next to nothing and real estate is seriously cheap ($100k range in major cities) because of foreclosures. People can buy so many other more practical and usable commodities in the US that have more value (work or man-hours to produce)? Why over-pay for metals that have been around for a very long time and are at historical highs and have been marketed like crazy through the media within the last couple years? Also, wouldn’t it make more sense to buy a metal more usable and less emotionally inflated?

Also wouldn’t it make more sense for the metals to fall in price if this recession is truly over–investors will put there money back into stocks. How convenient it will be for big metal investors to unload at historic highs right before the IMF will dump some gold and bring the price down. Won’t people who bought last year at similar highs want to unload there 0% increase one year later, or even people who bought at $700 range want to make their %30+ profit? All this marketing to buy gold and silver at these crazy highs is for the “new” investors or maybe better to call “suckers.”

5 tony bonn September 15, 2009 at 9:48 pm

john, you’re bad cult case or a shill for the oligarchs spreading the nonsenese you are advocating…..

who said gold is overpriced? your argumentation is just like thomas aquinas’ view that a good should be sold for a sufficient profit to enable the seller to live in the comfort expected of him by the community….what a crock….

others believe that it should sell according to supply and demand between free agents….as such gold is where it is and fundamental factors suggest that it is highly underpriced….

why would you want to buy a declining asset like real estate? sounds like advice coming from the blind leading the blind…

basing buying decisions on historical prices is moronic especially when monetary inflation is chronic….gold’s value has absolutely nothing to do with emotion….

who said that the recession is over or that risk has abated except for ben bernanke the very man who said he never saw any of the crisis coming? who would follow such a fool…..

if risk is low and growth in the cards then deploying money to working investments may in fact be a prudent trade-off…..however there is scant evidence that such conditions prevail….

in any event gold is money and you can never have too much…the imf
has not nor ever will dump gold….if it does it will move from weak hands to strong hands without a loss in value…

j0hn – god love you but i have heard boobs make more sense than you.

6 John Q Public September 16, 2009 at 8:59 pm

I’m not saying it should be sold only for profit, I’m asking what can you buy with it. Perhaps, I used the wrong choice of words. I mean there are other tangible assets to transfer your USD to than just gold and silver. Clearly buying gold now (at these prices) carries less of a value than it did years ago. And I’m saying if people think they are going to be safe buying up gold at this price they have another thing coming.

From the 1930’s to 1970 gold was about $35/oz. and nominal house prices were as high as $25,000 at 1970. It took about 715 ounces of gold to buy one house, or better viewed as, one house would buy you 715 ounces of gold.

Presently, gold is $1000+/oz. and the nominal house price for 2009 is about $160,000. It takes 160 ounces of gold to buy one house, or one house would buy you only 160 ounces of gold.

Au to house equivalents averages per year:
1970: 715 oz. Au =1 house
1972: 466 oz. Au =1 house
1975: 217 oz. Au =1 house
1978: 233 oz. Au =1 house
1979: 162 oz. Au =1 house
1980: 95 oz. Au =1 house
1981: 133 oz. Au =1 house
1982: 173 oz. Au =1 house
1983: 160 oz. Au =1 house
1984: 193 oz. Au =1 house
1985: 226 oz. Au =1 house
1990: 260 oz. Au =1 house
————————————-
1998: 382 oz. Au =1 house
1999: 430 oz. Au =1 house
2000: 465 oz. Au =1 house
2001: 517 oz. Au =1 house
2003: 468 oz. Au =1 house
2005: 495 oz. Au =1 house
2006: 417 oz. Au =1 house
2007: 335 oz. Au =1 house
2008: 218 oz. Au =1 house
2009: 160 oz. Au =1 house

During the late 70’s to early 80’s the oz. of Au to house ratio was similar to what we see now.

So, when gold prices are high you can sell it to buy other assets with it. However, there comes a point which people will stop paying for jewelry and industry stays away from it too because of its high cost. Also, when you buy gold you get less of it.

The people marketing gold at these high prices seem to use the belief it will go up to $10,000 /oz. and these prices are a great deal… which, if you think about it, is like saying that it takes only 10 to 20 oz. to =1 house if houses continue at their current prices and gold keeps increasing. This is just ridiculous.

There are other things that have more use in our daily lives, like real estate, as well as machine equipment and food. Unless you want to buy up as much gold as possible and live in a bunker waiting for civil war.

A wise man would hold a small amount of gold when the prices are right, sell some of their excess reserve to relocate into better real estate and buy Au back when the ratio is more appropriate and a “boob” would buy as much gold as they could now because it’s going to hit $10,000/ oz. and hoard it during a civil war.

7 Riekus September 20, 2009 at 1:02 am

Dear John Q,

Tks. 4 the excellent chart, very convincing.
But doesn’t yr. chart also clearly show, in the late 70’s when the house was 160 ounces, that it would be wise NOT to buy a house with it that year because the next year you could buy almost TWO HOUSES with that same gold? I agree w/yr. reasoning though, that we should use our gold/silver and exchange it for practical wealth at the right time, especially when one needs it (like a property or a laptop).
So the real question, the way I see it, is when, the timing of the exchange and this is what everybody is trying to figure out. If we knew, we’d be on the front cover of TIME magazine. Appreciate yr. comment.
The Crashconsultant

8 Trace Mayer, J.D. September 21, 2009 at 9:56 pm

As a rough guide I am looking at an Average american home around 500-1,000 ounces of silver or 70 ounces of gold and the DOW around 1-2 ounces of gold. If I pay a little bit more so be it as I am sure the tax differences will likely make up any difference. My goal is the acquisition of lots of cash-flowing real estate or cash-flowing businesses. While the public markets are fun the really good opportunities are found in the private sphere.

I have also started implementing gold clauses into contracts, negotiations, etc. I actually made a significant purchase earlier this year as I think gold and silver are getting more expensive. This particular purchase has already done extremely well for me. But I think the metals will get significantly more expensive before this complete transition is over so I am in no really hurry to convert them to various assets although I am always on the lookout for good value.

9 BlinggoingtoAsia September 22, 2009 at 11:29 pm

JohnQPublic said “Who is going to buy this over-priced gold at $1000+ and silver at $20+ per ounce? “. Answer, Asia (including the oil producing Middle Eastern countries). Pretty much the end of the story if you take the whole enchilada into context, I mean, who cares how our US dollar has gained and lost vs. precious metals and other assets like housing over the last 50 years, that is history, a blip on the radar. China and India are and have been buying physical gold and silver with ever more diligence, their numbers even at the low income levels that they are at will dwarf the U.S. physical PM buying (and selling) interests. Unfortunately, Billy Bob and Sally Jane are upsidedown on their 5 year-old-granite counter top home, the super-duty custom deluxe turbo diesel dooley truck they bought 3 years ago with a 60 month loan, the boat, off-road motorcycles, timeshares and the 9 credit cards that are about to go into collection just as Bill and Jane are getting pink slips at work. With BILLIONS of people in Asia living in near squaler daily and seeking even just grams of security in PMs, the potential is enormous, you’re living in a fishbowl if you can’t see that.

10 BlinggoingtoAsia September 22, 2009 at 11:44 pm

Bottom line is that much of our (U.S.) wealth has already been transferred to the Middle Eastern oil producing countries and at this juncture, the dollar is falling with political forces determined to drag it to it’s death regardless of who you are given as a representative to vote for, unfortunately, a bigger power is in charge of this chess game. The reality is that gold and silver have NOT gone up in value, the reality is that the dollar has gone DOWN in value making PMs appear to be highly priced but that is near sightedness on our part.

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