Worries of Gold Defaults Increase as Market Enters Backwardation

Futures markets under unusual strain as global flows raise eyebrows

Mike Gleason Mike Gleason
New Radio Release
August 1st, 2013 Comments

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Welcome to Money Metals Exchange's weekly market wrap podcast. Helping precious metals investors during these treacherous times. Now, here's this week's market wrap with commentary and analysis from the fastest growing precious metals dealer in America, Money Metals Exchange.

Mike Gleason:

Welcome to this week's market wrap podcast, I'm Mike Gleason.

On this special Thursday release of our weekly podcast, we'll examine how an unusual condition called "backwardation" affects the gold market.

Yes, gold has spent much of the year going two steps backward for every one step forward. But backward-looking analysis poorly predicts an asset's performance going forward. The straightforward fact that the gold futures market is now in a condition known as backwardation suggests that precious metals prices may soon start going two steps forward and one step back.

Okay, now if that introduction left you a bit confused, keep listening! Because in a moment I'll explain in clear language what backwardation means and why it matters to the future direction of the precious metals markets.

As for the market action this week, things were relatively quiet but the market had been weak heading into Wednesday's much-anticipated Federal Open Market Committee announcement. The GDP report that came out on Wednesday showed the U.S. economy growing at an annual rate of just 1.7 percent. That's far from being indicative of boom times, but the number was better than expected, so investors bid up stocks and sold safe-haven assets, including gold.

The yellow metal is struggling to hold above the $1,300 level, while silver can't seem to break and hold above $20 per ounce. Every week for the month of July brought a similar outcome in the silver market. Silver would tease us by moving above $20 during the week only to fall back below by week's end.

It's not unusual for summer trading to produce grinding sideways action. Trading volumes are lower, and the metals typically don't find a catalyst for large, sustained rallies until late summer and into the fall.

We do continue to see the precursors of a big rally coming into place however. One of them is the phenomenon of backwardation I alluded to earlier. Backwardation occurs when spot and near-dated futures prices are more expensive than longer-dated prices. The opposite of this is contango, which means forward prices exceed spot prices.

Normally, gold is in contango. It is accumulated as an alternative to national currencies rather than consumed like other commodities. Since gold is inherently money, it carries an implicit rate of interest, so it should be more expensive to buy in the future. When traders actually pay a premium to own gold in the present, it indicates supply concerns. They would rather put up more money today to get physical gold today, rather than pay less in the future and also get the use of their cash in the meantime.

If market participants won't defer their receipt of physical gold into the future – even despite the financial benefits of doing so – that means they REALLY want their physical gold right now and/or they feel there is a greater than normal risk of a failure-to-deliver default on a futures contract.

In July, we saw the spot market price of gold rise above the 90-day forward price. This unusual condition for gold signals extreme tightness in the supply of physical metal.

Backwardation has occurred only three times previously in recent history – in 1999, 2001, and 2008. On each occasion, the negative interest rates on gold lasted very briefly and occurred near low points for precious metals prices.

We are seeing a number of other indicators of stressed precious metals markets. Inventories have been drawn down to multi-year lows. Central banks are desperate to get their hands on gold and, according to some sources, they are dipping into the bullion holdings of exchange-traded funds in order to do so. There is a stealth gold shortage.

Governments are clearly trying to move scarce physical gold from private hands into official hands. The government of India has imposed numerous taxes and import restrictions on gold bullion to try to discourage its ownership. The consequence of that is an emerging black market. A secondary consequence may be a shift in the world's second most populous nation increasingly to silver, where above-ground supplies are even tighter and current prices seem even less sustainable than for gold.

In these unprecedented times, the best position to be in is to be able to hang on tight to an unleveraged position in real, physical metals. Money Metals Exchange specializes in helping people do just that. So if you have friends or family who haven't yet diversified into bullion, now is an ideal time to help educate them about the need to do so.

Well that will do it for this week's market wrap podcast, thanks for listening. This has been Mike Gleason with Money Metals Exchange, reminding you that we remain fully committed to getting you the most value for depreciating dollar... with speed, with accuracy and with top notch service. Have a great weekend everybody.


Thank you for joining us for this edition of the Money Metals Exchange Weekly Market Wrap. Be sure to come back next week, and don't forget to subscribe to our weekly podcast through iTunes. For answers to all of your questions, or to discretely and securely buy or sell gold or silver coins, bars, and rounds, call 1-800-800-1865. Our knowledgeable and no-pressure specialists are standing by between 7:00 a.m. and 5:30 p.m. mountain time, Monday through Friday. Visit us at www.MoneyMetals.com or call 1-800-800-1865.

Mike Gleason

About the Author:

Mike Gleason is a Director with Money Metals Exchange, a precious metals dealer recently named "Best in the USA" by an independent global ratings group. Gleason is a hard money advocate and a strong proponent of personal liberty, limited government and the Austrian School of Economics. A graduate of the University of Florida, Gleason has extensive experience in management, sales and logistics as well as precious metals investing. He also puts his longtime broadcasting background to good use, hosting a weekly precious metals podcast since 2011, a program listened to by tens of thousands each week.