Influencing Gold and Silver Markets, Backwardations Imply Higher Gold and Silver Prices

In Stock Market Investing: Will Reading Political Tea Leaves Be A Better Gauge?, we argued that today’s financial market can’t be used as reliable signals for interpreting future trends simply because financial markets especially in the US seem to be operating under the profound “influence” by the government.

And it seems that such “influences” have likewise been extended to the precious metal markets. Some agents of the banking sector, which has been under the lifeline of the US Federal Reserve, seems to have built heavy short positions in both the silver and gold markets.

Here is the excerpt (which includes charts) from Resource Investor’s Gene Arensberg,

``As of December 2, as gold closed at $783.39, the CFTC reported that 3 U.S. banks had a net short positioning for gold on the COMEX, division of NYMEX, of 63,818 contracts. The CFTC also reported that as of the same date all traders classed by the CFTC as commercial held a collective net short positioning of 95,288 contracts.

``That means that just three U.S. banks accounted for 66.97% of all the commercial net short positioning on the COMEX for gold futures.

Courtesy of Resource Investor (Source CFTC for Bank Participation, Cash Market for gold)

``For silver, it’s even more startling. On December 2, as silver closed at $9.57, exactly 2 U.S. banks held a net short positioning of 24,555 contracts. The CFTC reports that as of the same date all traders classed as commercial held a net short positioning of 24,894 contracts. So, the 2 U.S. banks, with one particular Fed member bank probably holding almost all of it, held a sickening 98.64% of all the collective commercial net short positioning on the COMEX, division of NYMEX in New York.

Courtesy of Resource Investor’s Gene Arensberg

``Exactly two U.S. banks have practically all the COMEX commercial net short positioning on silver. For a little context, 24,555 net short contracts means that the two banks held net short positions on December 2 for 122,775,000 ounces of silver with silver at $9.57. The COMEX said on December 4, that there were 80,239,857 ounces total in the “Registered” category, so these 2 malefactor banks held net short positioning equal to about 153% of the amount of deliverable silver in ALL the COMEX members’ accounts.

``And people wonder why both silver and gold moved into backwardation over the past two or three weeks? People are apparently worried that they won’t be able to take delivery of gold or silver metal from the COMEX in the future. They'll pay a premium now to get it now.”

In other words, the historical backwardation seen in the gold-silver markets accounts for as the brewing disparities between the precious metals’ physical markets relative to the financial markets or prices in the financial markets don't seem to be in synch with what has been going on in the physical markets.

To quote Professor Antal E. Fekete, ``Gold going to permanent backwardation means that gold is no longer for sale at any price, whether it is quoted in dollars, yens, euros, or Swiss francs. The situation is exactly the same as it has been for years: gold is not for sale at any price quoted in Zimbabwe currency, however high the quote is. To put it differently, all offers to sell gold are being withdrawn, whether it concerns newly mined gold, scrap gold, bullion gold or coined gold…(emphasis mine)

For us, the most probable explanation for such attempts to influence the precious metal markets is to create the impression that “inflation” remains subdued or contained. The US government wants to stoke “inflation” in the asset markets (stocks and real estate), but not in the commodity markets.

To add, by keeping the impression of contained "inflation", this allows authorities to liberally expand its theater of operations as it continues to wage war against debt deflation.

Moreover, such backwardation can also be read as the unintended effects from the distortions brought about by the attempt to influence the gold and silver market prices and as growing indications of the weakening foundations of the US dollar.

Again quoting Professor Feteke, ``Backwardation will pull in stocks from the moon as it were, if need be. The cure for the backwardation of any commodity is more backwardation. For gold, there is no cure. Backwardation in gold is always and everywhere a monetary phenomenon: it is a reminder of the incurable pathology of paper money. It dramatizes the decay of the regime of irredeemable currency. It can only get worse. As confidence in the value of fiat money is a fragile thing, it will not get better. It depicts the paper dollar as Humpty Dumpty who sat on a wall and had a great fall and, now, “all the king’s horses and all the king’s men could not put Humpty Dumpty together again.” To paraphrase a proverb, give paper currency a bad name, you might as well scrap it.

``Once entrenched, backwardation in gold means that the cancer of the dollar has reached its terminal stages. The progressively evaporating trust in the value of the irredeemable dollar can no longer be stopped.” (emphasis mine)

A prolonged backwardation suggests that price suppression schemes will only build unsustainable pressures underneath which will eventually find a release valve and consequently be vented in prices. Thus, gold and silver prices are likely to zoom to the moon!

Will Gold Reverse The Falling Demand=Falling Prices Feedback Loop?

``The world is lurching through a serious monetary disorder. The proximate cause is the collapse of the housing bubble and the subprime-credit crisis, but the ultimate cause is the inherently unstable monetary system foisted upon us by a banking cartel. Central bankers are called upon to act as lenders of last resort, but in their efforts to inflate their way out of the credit collapse, they risk igniting a hyperinflationary bonfire that will destroy the world's major fiat currencies. Gold was money once, and could become so again.”- Robert Blumen, Is Gold Money?

As discussed in Reflexivity Theory In Commodity Markets, there has evidently been a mounting disconnect between the demand-supply balance accounts in the real economy and the prices reflected in the financial markets, with emphasis for some commodities like gold and oil.

As the financial markets continue to read heavily into the “falling prices equals falling demand” feedback loop, streams of news continue to filter in on how gold coins or physical gold have been getting siphoned off the physical gold market as buyers apparently rushed to secure available physical gold stocks.

From Sify.com ``Mumbai: Financial crisis seems to have no impact when it comes to investor interest in gold. Multi Commodity Exchange of India Ltd (MCX) has witnessed a record delivery of 10,908 coins in its futures contract expired in October, surpassing the previous high of 8,900 coins for the August contract.”

From commodityonline.com, ``New data from London-based online gold brokerage BullionVault has confirmed that Britons are rushing to buy gold as they lose faith in traditional savings accounts, the Evening Standard reported…Accounts from the company show that it has grown by 475 per cent in the past year and now has 40,000 British customers and another 30,000 from around the globe. The appeal of BullionVault resides in its ability to provide the man on the street with a chance to get a fairer deal on gold - an investment of as little as £20 is possible - without additional fees.

From Arabianmoney.net, ``There has been an unprecedented surge in Saudi gold purchases in the past two weeks with over $3.5 billion being spent on the yellow metal, reported Gulf News citing local industry sources. Gold market expert Sami Al Mohna told the leading regional newspaper that this buying had substantially increased the gold reserves of the country: ‘Many Saudi investors see this as the right time for making investments in gold as the price is the most reasonable one at present’….News about the Saudi gold rush is bound to fuel speculation about the alleged large physical gold transactions that have been taking place at prices will above the spot price set in the futures market. It is very unlikely that such a large hoard of physical gold could have been bought for the depressed current price.

It is not just in the private markets but evidently even a minor global player like Iran has reportedly shifted out of the US dollars and into gold. This from Reuters, ``Iran has converted financial reserves into gold to avoid future problems, an adviser to President Mahmoud Ahmadinejad said in comments published on Saturday, after the price of oil fell more than 60 percent from a peak in July…"With the plans of the presidency...the country's money reserves were changed into gold so that we wouldn't be faced with many problems in the future," presidential adviser Mojtaba Samareh-Hashemi was quoted as saying by business daily Poul.”

And there are even reports that China is seriously considering to diversify part of its $1.9 trillion currency reserve into gold; this from Hong Kong’s The Standard, ``The mainland is seriously considering a plan to diversify more of its massive foreign-exchange reserves into gold, a person familiar with the situation told The Standard. ``Beijing is considering changing its asset allocations during the financial tsunami in order to build up gold reserves "in a big way," the source said…Beijing's reserves could easily go up to 3,000 to 4,000 tonnes, Tanrich Futures senior vice president Colleen Chow Yin-shan said.”

And even in the futures market, gold seems to have transitioned into a very rare backwardation or signs of immediate shortages. For basics, Backwardation is a market condition where spot prices exceed forward prices. Contango is the opposite condition, where forward prices exceed spot prices (riskglossary.com).

According to Minyanville’s Professor Lance Lewis, ``gold very rarely goes into backwardation: This only occurs when 1) The market fears a collapse in the currency, and/or 2) The market is worried about counterparties making good on their promise to deliver gold (which was briefly the case in 1999, when the Washington Agreement was announced and shorts were squeezed).” (emphasis mine)

Figure 5: Minyanville’s Lance Lewis: Backwardation in Gold Means Higher Prospective Gold Prices?

Figure 5 shows that gold lending rates have turned negative indicating emerging signs of shortages, again from Professor Lewis, ``We know gold is now in backwardation because the gold forward offered rate (GOFO) has now gone negative. The 3M GOFO has fallen 12 basis points to -0.07%, and the 1M GOFO has fallen 20 basis points to -0.1167% (see the chart of 3M GOFO below).”

On Friday, Gold made a rare monumental move to soar by 5.76% as shown in Figure 6.

Figure 6 stockcharts.com: Gold Shines Amidst “Deflation”

In the face of a rising US dollar, gold’s fantastic surge has equally been reflected in the US gold mining index ($djuspm) and the Goldman Sachs Precious metal index ($gpx), which suggests that the sudden spurt may have equally been confirmed by its mining counterparts.

Of course, we know that one day doesn’t a trend make. But gold’s one month consolidation seem to be indicative of an interim bottom. And the present surge could imply for a continued momentum over the coming sessions.

And with the global governments concertedly widening the liquidity spigot see figure 7 to defend against the menace of debt deflation, gold’s allure is undoubtedly gaining momentum.

Figure 7: BCA Research/US Global Investors: Gold As Liquidity Play

This tells us that many of the reflexivity justifications of falling demand/prices=falling prices/demand feedback loop will probably be overhauled soon. Once gold’s rise will be sustained, the public will change their rationalization to either safehaven or liquidity or inflation concerns.

Besides, putting the puzzle all together, we suspect that the Mises moment looks likely an imminent event, again Mr. Ludwig von Mises in Human Action [chapter 17: section 8],

``But then finally the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against "real" goods, no matter whether he needs them or not, no matter how much money he has to pay for them. Within a very short time, within a few weeks or even days, the things which were used as money are no longer used as media of exchange. They become scrap paper. Nobody wants to give away anything against them.”

We believe that the last laugh belongs to Mr. von Mises.