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18 Days and Counting - Silver Backwardation Persists in the London Market Place

By: Jake Towne

-- Posted 14 February, 2009 | | Discuss This Article - Comments:

This article and charts is an update to an earlier article "Silver in Backwardation! Has the Last Contango Been Danced in Washington?". The new text starts after the fourth paragraph.

[In case you do not yet understand futures markets, "backwardation" means that silver to be delivered today is now being priced higher than metal to be delivered later. This article refers to the LBMA, or London Bullion Market Association's futures market in London, England. For more details on backwardation, please refer to my five-part December series which starts here "The End for the Dollar and all Fiat Currencies (1/5)". Contango is the opposite of backwardation and exists when futures price is higher than the spot price as I explained for those new to futures terminology here "The Money Matrix - What the Heck Are Derivatives? (PART 10/15)". [As you read, please also note that I am NOT a commodities trader, I am just an engineer by trade, so feel free to help me out with my analysis or mistakes.] ( Photo) (2)

As we learned in "The Significance of Gold Backwardation Explained (4/5)", backwardation is a sign of a very tight market, and a market that will be tight for sometime into the future either 1) current supply is very tight, 2) future supply is projected to be very tight, or 3) there is a severe distrust in counterparties that the short positions can deliver the goods on time per the contract, or vice versa that the long positions will not have the cash.

While gold traded as a "store of value" (a currency, really), very little is actually consumed. Silver, on the other hand, serves as both an industrial metal and a "store of value" for silver investors. As we learned here, both silver and gold are precious metals since there is very little aboveground stock. All of the gold stock in the world would fit into a cube 20.5 meters to a side. Due to high amounts of industrial usage, the silver stock is even smaller, less than 14.5 meters to a side.]

Please refer to the below graphs of LBMA's silver mid rate, which is the midway point between the bid and offer prices. Here is what I note:

  • Silver has been in backwardation for the 18 trading days since January 21.  The mid-rate for the longest contracts is now slightly positive.
  • This backwardation is about three times more severe than the mild backwardation than existed from December 8 through December 24 in 2008.
  • We can see that since 2006-2007 where rates were about 4-5%, this state of backwardation is fairly unusual. (The LBMA only lists data back to 2006, but I believe it is a fair comment to say that on an even longer timeline, this is unusual.)
  • Furthermore, starting in roughly June 2008, the 12-month SIFO rate flipped over from being the lowest rate to, in general, the highest.
  • Also, the disparity between the rates seen in 2006-2007 has largely disappeared; the market appears to be treating a trade on silver 12 months later as quite similar to a trade on silver 1 month later.



[All graphs in this article were created by me from this LBMA source and this US Mint source and my file is available by request.]

Let's now also look at the LBMA Silver Fix price history for a 1000 troy ounce bar. Despite all of the tightness in the market as demonstrated by the SIFO chart, the Dollar price of silver is still well below the average price for 2006-2008, while Euro/Pound are nearing new highs due to FOREX market. During this latest backwardation, the Euro price is within 12% of its March 2008 high, while the Pound is within 23%. However, the dollar price of $13.37/oz. is 36% below its $20.92/oz. high.


It is simply too early to tell if we have seen the "Last Contango," but as Dr. Fekete notes in "The Last Contango in Washington" (2006) and "Keeping Our Eyes Peeled for the Silver and Gold Basis" (2007), the consequences could be very stark for the dollar and hence all fiat currencies.

Now, of course, there are many other factors as silver guru Theodore Butler points out in "Tightening Production". Industrial demand has been slammed by the economic fallout. However, since about 70% of all silver is typically mined as a by-product with other base metals like zinc, the supply is also greatly affected by the market conditions of zinc, copper, lead, and nickel. While the backlog in demand has greatly increased the inventories of these base metals causing a drop in their prices the inventory of silver is growing smaller while the price has increased over the past three months from $10 to $13/oz. Butler also relates that many of the base metal mines have been closing due since they are no longer profitable. At the same time, Butler reports that the American COMEX silver futures market is under investigation by the CFTC (Commodities and Futures Trading Commission) for market manipulation and price suppression. It is also possible the London market backwardation is temporary due to the severe loss of purchasing power (relative to others) of the British pound.

[For the Reader, NYMEX Gold Session Futures chart, Silver Session Futures chart. Gold spot price chart. Silver spot price chart. When the spot price is greater than the futures price, backwardation exists.]

Let's now take a quicker look at gold traded at LBMA. The GOFO, or Gold Forward Offered Rate, represents the rates at which dealers will lend gold on a swap basis against US dollars. From the below charts, I note:

  • Recently, gold has only gone into minor backwardation once, in November 2008, for 3 days.
  • As GOFO started its plummet in roughly September 2007, the prices began to diverge, and currently the 1-month GOFO rate is lower than the 12-month rate.
  • The buckling of the British pound can be easily seen. The British pound set an all-time high of 666 pounds per ounce of gold this week on February 12, 2009.
  • The Euro set an all-time high of 740 Euros per ounce of gold on February 12, 2009 as well.
  • Gold priced in Dollars is still 8% below its 2008 high of $1,023, as of February 13.



There is some debate about whether backwardation is bullish for gold and silver. Due to the aboveground stocks-to-flow ratio, I maintain that LBMA backwardation in gold in is not only a bullish signal, but, more importantly it is blaring siren signaling trust in the Dollar is being lost. Since the aboveground stocks-to-flow ratio of silver is more typical of other commodities and industrial metals, LBMA silver backwardation is also bullish, for the commodity but may not be as relevant to the Dollar unless the reasons for the backwardation are clearly understood. As an amateur, I do not know the root cause of the backwardation although I listed three possible causes earlier, plus the Pound's recent relative devaluation. However we can look at what happened to the price of silver and gold during each of the three backwardation periods from 2006-2009.


In addition to the annual supply-demand figures put together by the World Gold Council and the Silver Institute, another interesting item is US Mint-issued gold and silver bullion sales. As can be seen by the below, the gold demand quadrupled from its 2007 level, and silver demand doubled. Adam Hamilton wrote an interesting article recently here.


Another sign of investor demand is the GLD and SLV ETF's, which are probably fraudulent paper derivative scams as both James Turk and Jim Sinclair claim. The "inventory" of GLD has skyrocketed 205 tonnes to 985 tonnes since 2008 ended, which is within striking distance of the central bank reserves of Switzerland, the planet's #6 holder of gold. The "inventory" of SLV has leapt from 218 million ounces to 244 million ounces since January 1. In several weeks SLV will likely hit its allotted maximum of 264 Moz per page 8/48 of the prospectus. Not sure what happens after that, but if there are any SLV experts out there, please assist!  I've also noted some erratic behavior with the ETFs while LBMA is in backwardation, but I profess I do not have the expertise to dissect it further.

From the latest COT report, non-Gold Cartel traders should be wary of another initial pullback-breakout-retest-blastoff in the COMEX market which is how gold historically trades, as shown by Jordan Roy-Bryne. Others (like myself) of humbler means who do not like to play with the fire of the "Gods of the Market Place" should be quite content with holding the mythological metals of the sun and moon in the palms of our hands. For did Rudyard Kipling not warn:

"As I pass through my incarnations in every age and race,
I make my proper prostrations to the Gods of the Market Place.
Peering through reverent fingers I watch them flourish and fall,
And the Gods of the Copybook Headings, I notice, outlast them all...
In the Carboniferous Epoch we were promised abundance for all,
By robbing selected Peter to pay for collective Paul;
But, though we had plenty of money, there was nothing our money could buy,
And the Gods of the Copybook Headings said: "If you don't work you die."

Then the Gods of the Market tumbled, and their smooth-tongued wizards withdrew
And the hearts of the meanest were humbled and began to believe it was true
That All is not Gold that Glitters, and Two and Two make Four
And the Gods of the Copybook Headings limped up to explain it once more.

As it will be in the future, it was at the birth of Man
There are only four things certain since Social Progress began.
That the Dog returns to his Vomit and the Sow returns to her Mire,
And the burnt Fool's bandaged finger goes wabbling back to the Fire;

And that after this is accomplished, and the brave new world begins
When all men are paid for existing and no man must pay for his sins,
As surely as Water will wet us, as surely as Fire will burn,
The Gods of the Copybook Headings with terror and slaughter return!"

Fortune favors the brave. GO GATA!

Jake, the Champion of the Constitution

-- Posted 14 February, 2009 | | Discuss This Article - Comments:

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