Gold, silver in backwardation again

[krakknisse]

Gold and silver are in backwardation again. Silver is in backwardation out to three months. Since 1998, the 1 month gold lease rate (gold lease rate - LIBOR) has been in backwardation for 8 days, the 2 month rate for 1 day. Gold was in backwardation for 7 days in March, then this last one day on Friday. Gold has been in backwardation for 0.3% of trading days since 1998.

Backwardation means there is no risk-free way for a large gold holder to earn interest in lending out gold to a shorting party (lending out at the given rate, putting the earned lease rate in LIBOR for the period). There is no magic with the "less than zero". As can be seen from the charts, there is simply less profit in lending out gold, the lower the basis is.

Look up Antal Fekete's "Last contango in Washington (http://www.financialsense.com/editorials/fekete/2006/0604.html)" for an interesting story on why backwardation in a monetary metal is interesting.
http://i33.tinypic.com/23rtu1u.png
A longer-term view:
http://i34.tinypic.com/2igzs02.png

[zoog]

Thanks for keeping track of this krakknisse, I like the charts.

[Spartacus]

I stopped reading Fekete.

He thought "negative lease rates" meant the people with metal to give out on lease were PAYING people to take the metal (that the leasor was paying the lessee for the lease, not the other way around).

[Sapiens]

I stopped reading Fekete.

He thought "negative lease rates" meant the people with metal to give out on lease were PAYING people to take the metal (that the leasor was paying the lessee for the lease, not the other way around).

Link please, context.

[Lukester]

Gold and silver are in backwardation again. Silver is in backwardation out to three months.

Krakke -

Frank Holmes of US Global Investors is calling for Silver to touch the $30.00 price level "within 2008". I'm finding references to $50.00 silver within two years scattered all over the place. I sat up in my chair when I read Holmes calling the $30.00 this week as he's got a lot of institutional clients and a fair bit of reputation to protect.

Great input on the backwardation. Thanks.

Interested also to get Sapiens' take on the potential for this backwardation to extend.

[Spartacus]

It seems to me that regarding Silver, Fekete makes up a fact and seeks to bend reality to service his facts. Suspicious facts are accepted if he can bend them to support himself.

Fekete's colleague Szabo made the same mistake but corrected himself later.

http://www.kitco.com/ind/fekete/sep252007.html

The fact that he wrote this thing below, without pausing to think that something is screwy, and he never (as far as I know) retracted the statement is telling.

>>>>>>
Returning to the silver lease rate, this was not the first time it dipped into negative territory. The 30-day lease rate was pretty consistently negative between May 25 and August 4, when it shot up and reached a high of plus 0.4 percent on August 31. The fact that negative silver lease rates are not impossible but a well-observed fact of the silver market has exploded the myth of a world-wide shortage of silver. Come to think of it: lessors of silver are willing to pay lessees a premium for borrowing the metal. But before you rush over to ask lessors for free silver, you had better come to a correct understanding what negative lease rate means. The collapse of the silver lease rate on September 20 to negative territory meant panic short covering in silver. The shorts anticipated an imminent and substantial rise in the price of silver and were running for cover.
<<<<<

It does not mean any such thing - the reported "negative lease rate" is NOT a "negative lease rate". It's a fictional, calculated number the industry uses to indicate some information about current lease rates - it's NOT a "cost to do a lease" or "lease rate".

Thousands of words about Silver lease rates and no mention of LIBOR.

He constructs fantasies of too much Silver being leased too fast then being delivered to fast, all based on more fantasies of massive (undocumented, unknown, unknowable) worldwide Silver stockpiles - all based on a complete misunderstanding of what the published "Silver Lease Rate" actually is (it's not a cost to lease, Antal)

Link please, context.

[krakknisse]

http://www.kitco.com/ind/fekete/sep252007.html

The fact that he wrote this thing below, without pausing to think that something is screwy, and he never (as far as I know) retracted the statement is telling.

>>>>>>
Returning to the silver lease rate, this was not the first time it dipped into negative territory. The 30-day lease rate was pretty consistently negative between May 25 and August 4, when it shot up and reached a high of plus 0.4 percent on August 31. The fact that negative silver lease rates are not impossible but a well-observed fact of the silver market has exploded the myth of a world-wide shortage of silver. Come to think of it: lessors of silver are willing to pay lessees a premium for borrowing the metal. But before you rush over to ask lessors for free silver, you had better come to a correct understanding what negative lease rate means. The collapse of the silver lease rate on September 20 to negative territory meant panic short covering in silver. The shorts anticipated an imminent and substantial rise in the price of silver and were running for cover.
<<<<<

It does not mean any such thing - the reported "negative lease rate" is NOT a "negative lease rate". It's a fictional, calculated number the industry uses to indicate some information about current lease rates - it's NOT a "cost to do a lease" or "lease rate".

The gold forward lease rate (in percent) is always positive, otherwise there'd be a free lunch. The gold basis, however, isn't. The gold basis can be seen as the gold forward lease rate minus the alternative risk free rate of return. For now, LIBOR is used.

Fekete's very important point - and the reason I posted this for my nice and wise ITulipers - is that the alternative risk free rate of return, i.e. fiat money, is now not so attractive. Hence, the negative basis.

Let's try to do an example, for everybody's illumination. This is my first time trying to explain it this way. You're a a large gold bullion holder. There's a cost of carry, and your stash isn't earning any income. You can't meaningfully short it yourself to generate an income from your stash - it'd be the equivalent of selling a portion of your stash. It'd be profitable if the price fell, but given that most large bullion holders are long-term holders and selling isn't risk free, then that's not where you want to go. You can sell call options (or buy puts), but this is also not risk free.

So how can you generate an income from your static gold? If the gold forward price curve is in contango, you can play off that to earn money from your static gold. You do this by borrowing your gold out to a shorter. There's a small credit risk, but let's ignore that for this example. Take your 1000 ounces, and the current spot price at 1000 USD/ounce (e.g. the price at March 14th, 2008). The gold forward rate at 12 months was 2.06%. So you take your fee on the spot, and put it into the money market position at LIBOR, which was 2.51% then. You're up 4.56% in one year, and you still have your gold. Excellent!

How does it work for your counterparty? The shorter faces the following scenario. The shorter borrows your gold to sell it now at the spot price, pays you the lease rate, and then has to cover his short in 12 months, repaying your gold at the then current spot price. But the shorter could also just have stuck his cash that you, the gold holder, got as a lease fee, into a LIBOR account. That's why you need the LIBOR comparator. Your shorting counterparty could have gotten +2.51% in LIBOR for his cash, but instead pays you -2.06%. For it to be profitable to him, he needs more than a 4.57% fall in gold in 12 months. See the competition between LIBOR and gold forward rates? That's why the basis is important. As of Friday, a shorter needs a 6.12% percent fall over 12 months in the price of gold to go break even nominally. That is a tall order. Thus - the lower the basis, the more declining contango, the more bullish for gold.

And if you take into account inflation, your shorting counterparty faces an even more uphill struggle. Just to maintain purchasing power, he has to have an additional fall in the price of gold of 3-4% in addition to that (if you trust the official CPIs). So - as of Friday, gold needs to fall more than 10% in 12 months for a short position to be profitable.

Make sense?

There's a worked example in this thread (http://www.itulip.com/forums/showthread.php?t=4304), on a selling forward basis.

[Spartacus]

begin EDIT: since you're interested in basis, I believe Bart has posted some analysis of Basis you may want to look up.

I read it but not in detail. By the time Bart posted it I had already had my fill. Please Let us know if Prof. F. and Szabo ever post their basis inspired trades (BEFORE doing the trades) and if the trades ever make a profit.

:::: end addition ::::


I stopped reading F because his stuff was just too full of fiction.

Fekete claims to know all these specific details of how these massive, MASSIVE stockpiles of Silver are being used to turn a profit.

But he cannot document where this Silver is?

He can publish reams of attacks against Butler (full of hypotheses and guesses and suppositions) but never DOCUMENT where this Silver - a truly humongous, brobdignanian amount of Silver, is?

The gold forward lease rate (in percent) is always positive, otherwise there'd be a free lunch. The gold basis, however, isn't. The gold basis can be seen as the gold forward lease rate minus the alternative risk free rate of return. For now, LIBOR is used.

Too bad F didn't have your understanding - note the complete absence of "LIBOR" in the article I linked to. Note that he actually wrote (as far as I can understand that sentence) that some leasors were paying lessees to execute leases.

[Lukester]

I stopped reading F because his stuff was just too full of fiction. Fekete claims ... these massive, MASSIVE stockpiles of Silver are being used to turn a profit ... never DOCUMENT(s) where this Silver - a truly humongous, brobdignanian amount of Silver, is?

Great comments from Krakknisse and Spartacus both. Spartacus, I would very much like to believe your conclusions about Fekete were correct, and you raise excellent points about the "assumptions" that Fekete builds into his hypotheses. My problem, or call it a bias, is that I distrust virtually all conspiracists, and although Butler is brilliant, his notion that the massive short position allowed itself to slowly get "thoroughly trapped" is about as preposterous as is Fekete's notion that there is a massive hoard of silver bullion in some corner of the world in the hands of just one or two players.

Here's the supremely irksome part of all this. BOTH of those guys sound out to lunch on these corollaries. On the one hand, Butler's "trapped" short players, in short positions now verging towards the world's total annual silver production, (as though these two or three extremely deep pocketed players were so utterly stupid as to have wandered into that guillotine pen unwittingly), and on the other hand Fekete's truly gargantuan owners of a pool of silver who have been so supremely subtle as not to provide the world with even the whisper of a hint as to their identity for decades ( :rolleyes: ).

I can't stomach the one theory OR the other, and yet both of these guys in their own right are brilliant in many other ways. Frankly, Fekete is more brilliant than Butler because he ventures far further into monetary study, but I fully take your point. It's just possible on the silver question that Butler has the more acute "nose" as to what's really going down. Interesting discussion, and remains a thoroughly mystifying conundrum. Thanks.

What does Sapiens think about the large silver short position? We haven't heard back from him on that.

[c1ue]

KK,

There ain't ever any such thing as free money.

There is, however, such a thing as negative risk.

That's because there ain't such a thing as negative stupidity.

[krakknisse]

Gold is again in backwardation. No new curves today. 10 days in backwardation since 1998 - in March 2008 for 7 days, then on July 11th, and again on July 24th and 25th, for a total of 0.4% of trading days. The futures curve is flattening out to 12 months.

Shorting gold will become less profitable. Gold shorters can now put their money in LIBOR for a near equivalent return without the risk of gold increasing in price on a short position. Equivalently, gold owners not wishing to take a short position themselves have been reducing the price of loaning gold to shorters. In essence, the futures curve show that short interest is reduced.

In 1998, the typical 12 month gold lease rate - LIBOR was 2%. In 2001, 1.5%. In 2004, 0.3-0.4%. In 2006, 0.05-0.15%. In 2007, 0.15-0.5%. In 2008, 0.25-0.5%.

Silver of course has been in backwardation for a large portion of the futures curve for most of the year.

Bullish for gold and silver.

[krakknisse]

And then there is this, from Reuters: Gold options point to $1,200 (http://www.reuters.com/article/reutersEdge/idUSN2535920220080725):

NEW YORK (Reuters) - Heavy bets in deep out-of-the-money calls and other bullish plays in the gold options market indicate bullion has a shot at rallying to an all-time peak of $1,200 an ounce by the end of the year.

Gold has soared furiously -- a few years ago the metal was trading at $250 an ounce -- as investors poured into the market due to inflation fears, a weakened dollar and market turmoil.

"There are a lot of people who think that by the end of the year we'll be trading $1,200 to $1,500. They are not very expensive options, so people are buying them," said John Bilello, COMEX gold options floor trader.

Bilello said that many option investors were currently adjusting positions after gold's sharp fall but he saw recent strong volume of December $1,000 calls, bull call spreads between $1,200 and $1,300, and the selling of put options -- all of which are betting that gold will rise further.

A bull call spread involves buying a lower strike price call and selling a higher strike price call, and profits are maximized when prices rise above the higher strike price.

Option traders saw strong interest in the $1,200 December calls and other higher strike prices because they offered an affordable way for individuals to invest in gold's upside potential. more... (http://www.reuters.com/article/reutersEdge/idUSN2535920220080725)

Gold lease rates declining, meaning lower short interest - and options pointing upwards. Since gold lease rates are one of the tools central banks use to suppress the gold price, look for steep backwardation in the one month gold lease rate. That's what it'll take to get anyone to short gold. Nobody wants to take a long-term short position with gold in this environment, so the 12 month lease rate won't matter much. Bottle of champagne gets opened when the 1 month gold lease rate minus LIBOR hits 1%!

[bart]

The picture since late 2006 on futures.


http://www.nowandfutures.com/daily/gold_spot_futures_long_term.png

The dollar figures in parentheses in the legend are somewhat arbitrary adjustments in order to keep the various contracts prices within a reasonable scale.

[Lukester]

Well this has been a wonderful example of the reknowned Frank Holmes talking through his hat. What a crappy call, and one can expect his "institutional clients" would be underwhelmed with his supposed acuity on the resources sector as he has so thoroughly flubbed this call right along with everyone else. I would like to ask (Krakke, Bart, Spartacus, or anyone else here with a view on this) what the highly distorted new Libor rate does to the gold and silver basis now?

Any input would be appreciated.

Krakke - Frank Holmes of US Global Investors is calling for Silver to touch the $30.00 price level "within 2008". I'm finding references to $50.00 silver within two years scattered all over the place. I sat up in my chair when I read Holmes calling the $30.00 this week as he's got a lot of institutional clients and a fair bit of reputation to protect.

[bart]

I would like to ask (Krakke, Bart, Spartacus, or anyone else here with a view on this) what the highly distorted new Libor rate does to the gold and silver basis now?

Any input would be appreciated.

Libor rates and basis, like beauty, are in the eye of the beer holder? :rolleyes:

More seriously though, Libor rates do reflect an actual market behavior and the comparison between them and the 3 month T-Bill rate (a low so far today of .1% - yes one tenth of 1%), or a comparison with real overnight rates, or even a comparison of the 1 year Libor with the 3 month Libor, shows the same things - a massive move towards safety and away from risk... aka, yet more of the deleveraging boogie.

To the degree that market participants see gold and silver as a refuge and representation of safety, it is reflected in their prices - and spot prices are up very substantially today.

[krakknisse]

Well this has been a wonderful example of the reknowned Frank Holmes talking through his hat. What a crappy call, and one can expect his "institutional clients" would be underwhelmed with his supposed acuity on the resources sector as he has so thoroughly flubbed this call right along with everyone else. I would like to ask (Krakke, Bart, Spartacus, or anyone else here with a view on this) what the highly distorted new Libor rate does to the gold and silver basis now?

Any input would be appreciated.
Well, this is good news anyways:

http://i33.tinypic.com/307tbgy.gif

Popped over to LBMA. Today, the 12 month LIBOR-GOFO increased to more than 1% (which it hasn't done for YEARS). On my quick look, seems that LIBOR has increased more than GOFO for the last few days. Hard to call in this volatile environment.

I posted the Exter pyramid a while back. Hear that sucking sound? That's the sound of a mountain of derivatives and paper money being sucked through the very tiny drain of top-quality assets. Right now - history is being made. You'll tell your grandkids (if you have any - please do have them and don't end up like Jim N all grumpy) And at the very best bottom of that pyramid? Yes, you got it.

Krakke will slink back to his cozy gnomish corner of the stable (like that Harry Potter Elf). He'll be right some day :) No but seriously. Who the hell wants to bust his balls and have gray hairs in this kind of panic environment. Load up on the good stuff, lean back and watch the show. It'll never go to zero.

Even sheeple friends have started to worry. Headlines over here are all like "interest rates soar", "stocks crash", "is your bank safe".

[Lukester]

Thanks for your input guys. Pretty impressive moves today. I am earnestly looking forward to having made an utter fool of myself on the macro bearishness for PM's in the next 12 months - but we won't know that until long past this sharp rally.

[The Outback Oracle]

A wee rise in Gold equioties top go with it might be nice!

[Lukester]

Outback. Remember the Trojans at the battle of Thermopylae. Wait, until you "see the whites of the enemies' eyes". Then do whatever you decide to do, with advantage.

[bart]

A wee rise in Gold equioties top go with it might be nice!

Today, the HUI was up 11.7%, the XAU was up 8.5%, SSRI was up 20.4%, TRE was up 25.7%, MFN was up 12.2%, KBX was up 33%, NEM was up 9.3%, DROOY was up 15.8%, ABX was up 12.9%...


Picky, picky... ;)

[The Outback Oracle]

Grits teeth!:cool: