James Turk of the GoldMoney gold storage service has concluded that there is a steady pressure from gold buyers to take delivery of paper contracts for gold.
He offers this as evidence. The price of gold today is higher than the future delivery. Normally, the commodity futures price is higher for any commodity. Why? Because the seller wants to get paid for gold storage fees and the interest rate. But when there is heavy demand for delivery, the price of a commodity reverses. This is called backwardation. Today’s gold market in in backwardation. The one-month forward price is lower. Turk says we have seen this before: late 2008.
After the Lehman collapse there was a rush for liquidity, and gold is one of the most liquid assets. So it was aggressively sold into November of 2008, when the selling pressure ended as gold went into backwardation for a couple of days. And as proof that the baby was thrown out with the bath water, gold climbed from $717, at its November 2008 low, to $1,000 by February 2009. And it kept climbing for two more years.
This condition did not last long.
In contrast, the backwardation that ended Monday prevailed for a totally unprecedented and record breaking 40 trading days. During that time, gold rose from $1,200 to over $1,430. It was a spectacular jump in price. But with gold again below $1,400, the backwardation has re-appeared.
Why does this situation exist? On the surface, it does not make sense. There are no free lunches in life, such as storage fees.
Where are the arbitrageurs? Why haven’t they stepped in to take the easy profits? All they have to do, Eric, is sell their physical metal and simultaneously buy it back for future delivery at a cheaper price. Plus, they have use of the proceeds from their sale to invest. They also avoid storage costs while they own paper gold — a promise to pay gold in the future — instead of physical metal. For the big gold players it is easy money laying right there on the table, in plain sight for everyone to see. So why don’t the big players take the advantage of the arbitrage?
Is it because they fear the promise to deliver physical gold to them in the future will be broken? Do they value a tangible asset more highly than a financial asset? Do they believe the reward for holding physical metal is greater than the potential of a short-term profit?
We of course do not know the answer to these questions, but one thing is clear, this new backwardation illustrates that physical metal remains scarce, or in other words, it is being held in strong hands. It is therefore going take much higher gold prices to entice these strong hands to part with their metal and instead hold some depreciating national currency.
Remember Max’s law. Max Blumert was the father of Burt Blumert, who owned the Camino Coin Company for 50 years before he died. “Buy the best. Pay cash. Take delivery.”