Gold Backwardation: When Good People Make Bad Comparisons

You may have heard some talk lately of 'gold backwardation.'

Backwardation is a pricing phenomenon in the futures markets where the price of an asset now is higher relative to the price of that same asset in the future. 

The usual state of most assets is one of contango, where the price increases in the future. This is often due to the time value of money. But let's put that aside for now. Especially in times of ZIRP.

And there is the source of the term backwardation.  The pricing is literally 'backwards.'  I don't remember where the heck contango comes from, and don't care, but that is a shortcut in how I remember the difference between them. 

There are strong indications in the gold market of short term physical supply pressures. Gold Forwards prices are negative, and in a way that we have not seen in some time.   Registered or dealer inventories on the COMEX exchange are at record lows for this leg of the bull market, something that has signaled a change in price trend since the gold bull market began.  Reports of tight supply in the physical markets have been in the news especially in Asia.

The German people asked the NY Federal Reserve for the return of their nation's gold bullion that is being held in custodial trust, and the Fed said 'no can do, Fritz, come back in seven years.'  Are you shitting me?  If that does not get one's attention, you have to wonder what will.

But the fact remains there is not much 'backwardation' on the gold futures market at the COMEX. Below is a chart showing the contract pricing over time. What's up with that?

Furthermore, some astute market observers have pointed to the pricing structure in the oil futures market, and rightfully observed, 'Now THAT's backwardation!'

So what does all this mean?

First of all, one has to look at what is usual and customary for a given market, in addition to making cross market comparisons.

When one is comparing the body fat to weight ratio of a polar bear and a flamingo, for example, one might assume that the polar bear was rather unhealthy since in general too much fat is bad, and the polar bear has quite a bit more than a flamingo. Unless of course if one understands that what is normal for a polar bear may not be normal for a flamingo, because there are some basic structural differences between them.  One always compares a thing to itself, to establish the trend and the norm, in addition to something else, in order to accurately ascertain any changes in condition.

If the gold market ever goes into the type of backwardation shown in that oil chart above, I submit that you will not have look at a chart on the internet to figure out why. You will be more concerned with getting long bread, bullets, and bibles, because the economic system will be going up in the flames of some currency failure, barring some anomalous corner on the market such as we saw in silver with the Hunt Brothers and silver.

And yet with oil in that type of backwardation as we see above, nothing is particularly going on in the world.   One might assume that there is something particular with the oil market that is not indicative of the general economy and money.   Oil, while not perishable, has a cost of storage and delivery relative to the utility of a barrel available for distillation and sale as something else that makes for some natural arbitrage opportunities. Its more complex than that but you get the general idea.

So why are not seeing at least some greater degree of backwardation in gold than we see now, throwing out the awkward comparison with oil which is obviously different in character from precious metals?

Well if the problem is a shortage of supply of physical gold bullion, would one go to the COMEX to get it?  The COMEX is a locus of the supply problems,  being a paper market with record leverage or claims to available supply.  Why would you go to the source of the scarcity in order to relieve it? You would try to get the bullion from someplace else.   Do you go to the desert to find water to relieve a drought?  No, you go to where the water is likely to be found.

The backwardation thing, being specific to the futures paper market, is not all that important for gold, for the reasons cited above.

Thanks especially to Dave of Golden Truth for tracking the gold forwards for us.   I will continue to keep an eye on price and supply, and consider the technicals as they are appropriately applied.   

JP Morgan Retirement Exits Hedge Funds and 'Pulls Back' From Equities

Let's see, JPM's customers have withdrawn most of their gold from the COMEX vaults almost overnight, along with Brinks customers.

And now JPM's Retirement Fund is dropping all exposure to hedge funds and pulling back from equities because they don't need the money.  Apparently return on investment is an outmoded concept.  Especially when you may be in a position to see some formidable vagaries of the market heading in your direction.

Nothing to see here, move along.  All is well.

Curiouser and curiouser. 

Highbridge Owner JPMorgan Chase Cuts Hedge Funds From Pension
Jul 25 2013
9:57am ET

JPMorgan Chase is one of the biggest hedge fund managers in the world, managing billions for pension funds. But its own pension isn't sure the asset class is worth the risk anymore.

J.P. Morgan Retirement plans to liquidate its entire $2.3 billion hedge fund portfolio, which accounts for about 18% of its $13 billion in assets. The bank's pension is able to make the risk-cutting move.  It will also pull back from equities ­because it is that rarest of things: an overfunded pension system, with enough money to cover 117% of its obligations.  (Yes that's right therefore they don't need any returns - Jesse)

Eliminating hedge funds will "immunize" the pension from the vagaries of the market, a source told Hedge Fund Alert...

Read the original at FINalternatives here.

NAV Premiums of Certain Precious Metal Trusts and Funds - Diversity of Judgement

"A wise man proportions his belief to the evidence."

David Hume

And the pedestrian thinker confines themselves to following well worn paths where little that is new can be discovered.

There is a fascinating market structure in gold as you know if you frequent this café, that revolves around the COMEX.

Occasionally I get questions about what some other people are saying about this.  This is apart from what is said on the financial networks, which  far too often is an extended infomercial with the intent to persuade and mislead.

I generally don't like to comment on other people's work, especially when it is just about an opinion.  Opinions can differ greatly and most of the time it is not worth discussing.  I read a piece someone sent me on the COMEX that was filled with lots of facts, but few of them were relevant to the heart of the discussion about the structure of the gold market. 

This is thinking by the regurgitation method.  One learns it in school.  When asked a question, a load of facts are spewed forth on the paper, but there is little of substantial value in that particular collection as it has been arranged.  The facts are like ornaments on a tree, that contribute nothing to the structure that supports a conclusion.

When reading what someone says, one always tries to sort out what is factually based, and what is just opinion, a guess, or just rhetoric. You can evaluate the facts, and the rest is what it is. And yet we keep in mind that much discovery involves the marriage of art with science. It is critical that art does not overshadow reason and obtain sole custody of the children.

Facts matter, and opinions are sometimes what could be called judgement, which everyone exercises since the data does not often present itself so completely in the real world that things become simple and undeniable math.   Judgement is how one bridges the gaps in their data to reach conclusions, which naturally are of varying quality.  One calls them hypotheses until they are proven, or disproven.

Judgement comes with experience, but it is also subject to emotions and idiosyncrasies of the mind.  Managing one's judgement is one of the most critical tasks the advanced investor must endure, as in the case of any advanced thinker in any field.   People are not computers, but living breathing beings of a complex nature and it is rare to find someone who is completely objective, although many would fancy themselves to be. 

I recall reading a nice description of the gold forwards arrangement for example.  After a long exposition which was really quite good and complete, the author concluded by dismissing the entire area as silly and useless because the data was not available to him in exactly the way in which he wanted to have it when compared to other sets of data with which he was more familiar.

If only life were so simple, and so compliant.  Data differs in quality and quantity, always.  Because some data is more complete than other data does not make it superior to other data, especially when the quality of the data can be called into question, and the problem one is approaching is somewhat complex and parts of it are hidden.   Everyone is familiar with the old saying, 'garbage in and garbage out.' 

The sorting and evaluating of data from various sources is the basis of the scientific method, and one examines all the available data, not just that which pleases us the most because it looks nice on paper, but could in fact be wrong.  

And the great trap is to become too familiar with a problem over time, so that one obtains an emotional stake in a particular aspect of the problem.  Then it becomes MY data and approach, versus all others.  This is commonly called 'not invented here' and it is much more common than you might think.  And not just in others, but in ourselves.

Most of the time when people encounter something that differs or varies from what they believe to be true, rather than evaluate that persons facts and sort them, they begin by trying to prove them wrong with any and all means at their disposal, often relying on rhetorical tricks and device.  They are really fooling themselves.  That is why so many of these 'debates' that get staged are diverting, but useless.

At the end of the day, be your own best critic.  That is to say, before you find faults with others, look at yourself, and assess your own work to the highest standards you may obtain.  Look for any flaws in it, and try to knock it down with the same rigor and attention which you might apply to some imagined adversary.

And then you may look with a critical eye at what others present, and take what is solid and worthy, and consider the rest on its own merits, subjecting your own body of thought to the same rigorous scrutiny, always.

This is the answer to why I present my work in public, and take nothing for it.  People ask me about that all the time, why I take no advert money or ask for no donations.  Besides the fact that I do not need them, thanks be to God, the work itself is the reward.  And of course the people one meets when sifting through the stacks in search of hidden gems.  I was an antiquarian bookman for over twenty years as a hobby when traveled the world, and cultivated the habits, pre-Internet, of patient searching through nooks and piles of material, with a patient purposefulness.  Those were good days and charmingly eccentric places and people that seem to be gone forever.  But new days, new challenges, always come.

It is harder to fool yourself when you are forced to put your thoughts down on paper, and to present your reasoning.  It presents an impedance to one's thought that makes it stronger, more robust.   If you have an opinion, label it so.  If you have reached a conclusion, show the facts and your logic. 

And if you have a judgement, that is all well and good, but make sure you understand the risks in your own conclusions and adjust for them accordingly, and be honest in showing them to others.

It has often been shown that collective judgement can frequently be insightful because the idiosyncrasies of individuals are lost in the collation of perspectives.  One of my professors was a pioneer in that field, and his work influenced me greatly. 

That of course presumes that the judgements are all of a certain quality and not merely whimsical opinions.  One of the great faults is to presume that all judgements are of comparable quality.  They are obviously not, despite the notion that each person is entitled to their opinion.

Having said all that, there is certainly something odd going on the gold market.  That is undeniable, and when some dismiss this as conspiracy, well, that is because they have nothing better to say, but it makes them appear to be wise.

I wish I could tell you what will happen with certainty but I cannot.  But I can keep myself informed on the progress of an unusual condition, relying on all the metrics and data at our disposal.  Yes it does vary in completeness, and not all of it is equally relevant.  And as I put it down I look at it from a distance, and see what it has that is sound, and what is not.

And this endeavor is complicated greatly by the undeniable fact that our markets are subject to fraud, and even key metrics have been shown to have been rigged.

Anyone who does not take this into account, who denies this now known fact, which many have asserted for some time based on circumstantial evidence, is not worth the time it takes to read them. 

They are just ostriches with their heads in the sand because it comforts them.  And the best we can do is not join them in this, and to check carefully for the sand in our own eyes, before looking for the sand in the eyes of others. 

Gold Daily and Silver Weekly Charts - Tomorrow Must Be COMEX Options Expiration

"Major Strasser: Are you one of those people who cannot imagine the Germans in their beloved Paris?

Rick: It's not particularly my beloved Paris.

Heinz: Can you imagine us in London?

Rick: When you get there, ask me.

Captain Renault: Hmmh! A diplomat!

Major Strasser: How about New York?

Rick: Well, there are certain sections of New York, Major, that I wouldn't advise you to invade."

Casablanca

Similarly, while there are certain market manipulations that in the short term may appear to be tempting, they may not be advisable given the potential for profound consequences that, while unintended, could prove to be significant.

There was intraday commentary on the slanting W chart formation on the gold chart here.

The action in the precious metals remains labored. The structure of the market is breathtaking.

Tomorrow is option expiration on the COMEX. The following week begins the August delivery period.

I will try to keep you informed as best as I can.

Have a pleasant evening.