A Hint of Gold Backwardation

Rising Scarcity and a Nascent Change in Trend

Last month, we noted that there could be a trend change in progress. Not only are the prices of the metals rising (which is just a mirror-image of the dollar falling, from 27.6 milligrams of gold just before Christmas to currently under 26mg). But the scarcity of gold as we measure it, using the spread between the price of gold in the spot and futures markets, has been rising.

What could cause this? One thing is for sure. It is not about the quantity of dollars. This theory is as popular as ever, despite the absolute lack of a rising gold price from September 2011-2016. The quantity of dollars has risen steadily since then.

We write much about the frequent cases when traders place big bets on something which is wrong. But the fact of their big bets drives up the price. Suppose speculators were betting on a big increase in the quantity of dollars under Trump. Then we would see a rising price alright, but we would see a rising basis — our measure of abundance of gold to the market. This cannot explain the current market either.

So what can? Recall my gold backwardation thesis. In times of stress or crisis, it is always the bid, and never the offer, which is withdrawn. Suppose the US Geological Survey were to make a dire announcement— they are not saying this, so do not misconstrue!!

Suppose they said that there will be an earthquake in LA, an 11 on the Richter Scale. Nothing taller than a dollhouse will be left standing. There would be no lack of offers to sell real estate. Some would hold out hope of getting “their price”. Others would generously offer to discount it 10% or 25% from the previous level.

However, what would be conspicuously absent would be a bid. Most likely from Santiago Chile to Vancouver, British Columbia and as far east as the Mississippi River. At least until the quake hits and the danger has passed.

It is gold that will withdraw its bid on the dollar. The bid sputtered eight years ago, and intermittently since then. Then it has mostly been steady in the past few years. And now there is a hint of it, in the February gold contract. It is just what we call temporary backwardation — a short term blip, confined to the near contract that is heading into expiry.

However, we still think it is notable. It means someone or many someones are switching their preference to gold, in spite of the higher yields available in the market now. Or maybe because of them. This preference, unlike speculators who are buying futures with leverage, is not about betting on price. It is about safety. Gold, unlike a bond, cannot default.

Is this the explanation, and the whole explanation? We don’t know. We can only report that there is a change in behavior in the market. Whereas previously — this was the pattern for years — a rising price was accompanied by a rising basis. And now we have rising prices and the co-basis is rising instead. Rising scarcity rather than rising abundance.

To be sure, it is still a nascent trend. There is no guarantee that this phenomenon won’t go poof like it has in the past. We will keep showing the data, and call it like we see it.

Indeed, look for a new website soon. We plan to have more charts, many more, which will be updated daily – including one data series that all the experts said could not be calculated.

All the gold in the world (excluding Ben Bernanke’s grillz collection). The estimate appears a bit dated, but even if we e.g. assume that there are  about 180,000 tons of mined gold in the world, the cube would only be slightly larger (approx. 20.5 by 20.5 meters, or 67.25 by 67.25 feet).  There is actually considerable uncertainty regarding the total amount of gold mined in the course of history, but the fact remains that it is quite rare. At the same time, its existing stock is very large compared to the flow of new gold supplied by mines every year. The large stock and only slowly growing stock is one of several reasons why the market has chosen gold as money. [PT]

Fundamental Developments

Below, we will look at the supply and demand fundamentals for gold and silver. But first, the price action.

Prices of gold and silver

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Gold-silver ratio

The next graph shows the gold price measured in silver, otherwise known as the gold to silver ratio. It fell a bit this week.

Gold-silver ratio

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For each metal, we will look at a graph of the basis and co-basis overlaid with the price of the dollar in terms of the respective metal. It will make it easier to provide brief commentary. The dollar will be represented in green, the basis in blue and co-basis in red.

Gold basis and co-basis and the dollar price

Here is the gold graph.

Look at that rising red line, the co-basis (our measure of scarcity). Since mid-December, it has moved opposite to the green line, which is the price of the dollar. Previously, they were moving together. That is, a rising dollar (i.e., a falling price of gold, as measured in dollars) went with rising scarcity of gold, and a falling dollar with falling scarcity.

And now they are negatively correlated. The more the price of gold is bid up (i.e. the more the dollar is sold), the scarcer gold becomes.

On Friday, our calculated fundamental gold price was just about $100 over the market price.

The February co-basis stands at +0.12%. That is, the February contract is in backwardation.

Gold basis and co-basis and the dollar price

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Silver basis and co-basis and the dollar price

Now let’s look at silver.

In silver the co-basis is rising a bit, though it is at a much lower level. Far from backwardation, it stands at -0.90%.

Our calculated fundamental price moved up 3 cents from last week. It is no longer above the market price, as that moved up a lot more.

Silver basis and co-basis and the dollar price

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