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Backwardation Should Be Normal

By: Jason Hommel, Silver Stock Report

-- Posted 10 December, 2008 | | Discuss This Article - Comments: Source:

(For a rational people)

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Tonight, Wednesday evening, in about 4 hours, I auction off 5000 oz. of Engelhard bars, starting at $10/oz., in minimum of 500 oz. lots.

Thursday night, I've put another 5000 oz. up for auction.

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If two vendors are selling silver, and one promises delivery in 3-5 days, and the other is backlogged for 30-60 days, then where would you prefer to shop?  Clearly, you would rather get delivery now.  And in the industry, in silver, it usually costs more to get silver now, rather than wait 2 months.  So, backwardation, in that sense, should be normal.

The silver coin and bar market is unlike the futures markets, of course, because buyers of physical silver are all paying full price, in advance. 

The difference with futures is that you can lock in a future price, with a small down payment, and then invest the difference in 30 day T-Bills to earn an interest rate.

The interest rate is supposed to mirror the inflation rate, so gold in the future should naturally cost more as mild inflation is always expected.

However, if a default, or failure to deliver gold is expected, then future gold prices fall.

Gold in backwardation appears also to be a function of just below zero interest rates on the near term T-Bill. 

But why would people prefer a T-Bill over cash?

And yet, in gold, people prefer cash gold over future gold!

I suppose people interested in gold vs. future gold are smarter than people who are choosing between cash and T-Bills!

It seems as if the T-Bill buyers are brain dead zombies, buying T-Bills out of reflex or habbit, not even checking the price, even as they lose money to buy them!

Perhaps T-Bills offer more "perceived safety" than cash (even if they cost more) since cash in the bank has a low limit of $250,000 of FDIC insurance?

Backwardation is seen as unusual only so long as investors are thinking in terms of "risk free" profits in the form of paper cash gains, and a gold delivery default is not expected.

Backwardation is seen as normal when people begin to see the difference between gold and paper promises, that the two are not the same.

Under the gold standard, paper money nearly always traded at a discount to gold, because of the extra time, hassle, and risk of returning the paper money to the issuing bank to get gold.  Back then, the further away the bank, the greater the discount that paper certificates had.

Thus, under a gold standard, when people were rational, backwardation was normal.

Only in our crazy paper money era, is gold backwardation unusual.

I agree with Fekete, for the most part, on this one.  Backwardation is a fantastic signal, very positive for gold and silver.  It means people are beginning to wake up from their fantasy of paper money dreams.  They are beginning to return to normal.

I disagree with Fekete when he calls the upcoming gold bull market a "bubble that never pops".  No, the bubble was in paper money.

In the past, in 1980, paper money survived primarily due to two mechanisms. 

1.  Very high interest rates exceeding 20%.
2.  The existence of futures markets to siphon money away from going into cash gold, and into futures gold, for the false lure of "promised" extra leverage and extra gains, instead, (which rapidly turned into losses from 1980 onward).

Today, those mechanisms to divert money away from gold appear as if they are being destroyed.  What is there to stop people from buying gold, and earning the average annual gains of 30% or so?  Almost nothing.  The gold and silver bull markets will be unstoppable this next time around.  Paper money is far more likely to die completely.


My readers comment on the default of Canadian Banks to redeem silver certificates for silver:

Hi Jason,


Ive been subscribing to your emails for a while, and just wanted to say thanks for the free service. Ill briefly share my Canadian silver story:


In August 2008, I bought 2x 1,000 oz of Silver bars through the bank of Nova Scotia here in Canada, though I had requested 5x 1,000 oz that day. They were only able to offer delivery on 2x, so thats all I bought. They were completely out of anything lower than 1,000 oz and according to the Toronto people on the phone (back in the vault??) they only had 2 bars left, so thats all I got. Meanwhile Gold at that time was still easy to acquire, and they said they could deliver on almost any denomination and I ended up using the rest of my money on buying gold instead. I should mention that the delivery of the Silver was extremely expensive. I paid $1500 Canadian (roughly $1200 USD) to have those 2x 1000 oz delivered from Toronto to Vancouver. Air shipping was the only option (I asked for land shipping options), and I imagine part of the cost was insurance. Gold was much cheaper to get delivered.


The last thing I wanted to share with you is that there is now a website that is trying to graphically chart COMEX Gold & Silver inventory levels with the goal of trying to show that they may eventually default on delivery. You should take a quick look at this, as I think your subscribers may find this very interesting.


Comex default charts (Gold & Silver): 


Thanks for sharing and please keep doing so,







I think it was sometime in late October that I walked into the local Trenton Ontario BNS--not the bullion bank--, but local branch of the Bank of Nova Scotia and asked the lady in charge whether they were still selling silver certificates--I was told with a guffaw that they "would sell me all the certificates I want!" I then told her that there was no silver in the system and that storage fees would still be charged and would not the constitute fraud for the bank?" She stopped smiling immediately and said she would look into it--.She did--and phoned me a day or two later - to her credit - and said that there was a "some" silver down at ScotiaMocatta in Toronto. At that time, I knew there might be a few 1000 ozers but no small silver there--.But still she did look into it--.Later I talked to another local BNS with the same question and just got glared at,--.
To be quite honest I expected there to be a huge cry of fraud over this situation by now--,but have heard nothing--.That doesn't mean there isn't a mess out there in the Canadian banking sector over this--,it just means that the yelling may be going on in private and spilling over into lawyers offices--,,I hope. One shouldn't underestimate the constraints that can be put on in procedural ways to quiet the news from getting out--.If one goes public with a scandal in Canada, one can get sued for slander quite easily and by some very deep (still) pockets--,in spite of being correct about the news--.Similarly, the media would be hesitant to wade into this mess for the reasons silverbugs are well aware of--,and the usual reticence of avoiding offence to the financial entities that support the advertising revenue--.We do live in interesting and increasingly contrarian times where the "truth is out there" but it is generally found out the hard way,---- Right now we have a deafening silence on the subject when I expected long lines and lots of verbal ire when the metal ran out--.It didn't happen and from this end, we are virtually out of silver and seemingly nobody cares--.This is not what I expected and I hope that this is going to change. But I doubt it--.
95% of "silver" is held in paper form and a huge PUBLIC percentage is held in certificate form--.I surmise that the larger holders--,those that have a certificate position of several hundred thousand ounces are yelling at their lawyers--,,and the rest are oblivious because there is little care about small positions--and of course the aforementioned no news coverage--,,or these small fry paper holders are quietly just cashing out and taking their lumps--er losses--FWIW.
The large holders, if they started yelling soon enough might actually see some metal--,but if one assumes that each ounce in certificate form is sold on average a conservative 10 times (in Canada)--,then it stands to reason that the first one in the line of ten gets that ounce--and the rest get cashed out--.And then there is the question of how many actually wanted the metal in the first place (having bought paper instead of metal) and we have an additional complication that most of these folks were in it for dollars anyway--.


Silver is available for immediate delivery at

Tonight, Wednesday evening, in about 4 hours, I auction off 5000 oz. of Engelhard bars, starting at $10/oz., in minimum of 500 oz. lots.

Thursday night, I've put another 5000 oz. up for auction.

Oh, about 5-10 people asked me why I'm selling silver if I'm so bullish on silver.  I discovered that the size of my holdings enable me to buy up to 5000 to 10,000 oz. of COMEX good delivery bars at a time in the spot market (not from COMEX), which is about the minimum necessary to work with some of the mints to make more 100 oz. bars and coins.  I hope to be able to scale up to sell about 50,000 oz per week.


Jason Hommel

-- Posted 10 December, 2008 | | Discuss This Article - Comments:

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