Ever since early fall 2010, long-dated silver futures have been in backwardation. This means the price of a silver future for, say, Dec. 2015, was lower than the price of silver in the spot market. One could have earned a “risk free” profit by simultaneously selling physical silver and buying a future. When the future delivered, one would have the same silver holding. The trade would require no credit, only that one have silver (which many people and banks do). And yet for nearly a year and a half, the backwardation persisted. This is because it was not risk free. There is one risk: default. What if the future did not settle in metal, but in paper?
The backwardation has been subsiding for a long time. A year ago, silver was backwardated for contracts in 2013. Last summer, it was only contracts in 2014. Recently, it has been only 2015. Yesterday, around 9:30 am PST, the backwardation disappeared altogether. And this new market condition appears to be holding.
The enclosed graph is a snapshot. At one instant in time earlier this morning, I grabbed the basis and cobasis for each future contract in silver out to Dec. 2016. Recall the basis is the profit one could make by buying physical and simultaneously selling a future. The basis, represented by the blue line, is positive through 2013. The cobasis, represented by the red line, is the profit one could make by the arbitrage I suggested above: sell physical and buy a future.
The cobasis is now not positive, i.e. there is no profit, for any contract out to Dec. 2016. This is not bullish for the price of silver.
But I want to touch on something else. Since December, and especially in the past several days, liquidity spigots have been turned on full. Yesterday, everything from copper to equities to the euro to silver rallied relentlessly. From the change in the silver term structure, it’s obvious that there was some significant selling of physical/buying of futures. This is the only action in the market that could eliminate a backwardation.
The flood of liquidity provided a cover for selling of physical metal, and prices actually rose during this process. Now the banks have corrected their duration mismatch in silver lending (or whatever was the root cause of this persistent backwardation). Once this process plays out, then the marginal buyer of futures leaves the market. If the new non-backwardated state holds, the price of silver could fall hard.
The irony of this is that the conspiracy theorists of the world will attribute the price fall to naked short selling of futures. As soon as the bout of liquidity ends, watch out below. And watch for the conspiracy theorists.
The thing is, it’s been a good while now since the price of silver could be considered bullish, despite backwardation.
Also, these floods of ‘liquidity’ can hardly be reducing the risk of default. Speculators are selling physical & buying futures on the back of an already dubious central bank promise?
I remain unconvinced that these futures spreads are signalling anything but potential speculating opportunities for speculators. I think any spread between allocated &/or physical demand & unallocated is a better metric for the final gasp of the present ‘monetary’ system. According to Bron at the Perth Mint there has been no movement in the spread. Perth Mint still receives truckloads of silver & gold loco London through its unallocated account with a bullion bank.
Not disagreeing with you that the silver price may fall though.
Jim Rogers thinks the price of silver has a bigger upside than gold http://www.cnbc.com/id/46425613. There is often a mismatch between the time that there is a change in the level of the backwardation and the change in the price of the underlying. The price of silver has already taken quite a fall from its high of ten months ago.
Most research I have done and others point to silver as the investment of the decade, time will tell though
Rick Rule, James Rickards, Jim Sinclair, Mr. Barron, Stephen Leeb, Keith Numyer, James Turk, Turd Ferguson and many other are all gung ho on silver in the years ahead. If fiat money devalues how can silver, and yes gold fall ?
why do you say this Keith ?
We have to put the backwardation in silver in proper perspective. This means that we have to consider it in the light of the open interest and volume figures of the distant futures. These contracts are illiquid and this distorts their importance. Strictly speaking, the silver basis is the difference between the price of the NEARBY futures and the spot price of silver, the nearby futures contract being highly liquid. Once backwardation occurs for THIS basis, then it is time to get excited. It could still come out of backwardation, and one should keep a tab how long it was backwardated, how frequently such backwardation occurred.
It will be interesting to see whether Keith is right in predicting a significant fall in the silver price on the strength of the disappearance of backwardation in the distant months. To prove a strict correlation between the two events would take a major efforts. There is a PRIMA FACIE case, since the more distant futures came out of backwardation one after the other, in the same order as their distance to maturity increased. But this may mean that those with inside information know that new supplies of silver are on their way to Comex warehouses which in itself is not bearish for silver.
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JR: I would not call someone who trades the silver spreads a speculator, but an arbitrageur. I know many people look at spreads between allocated and unallocated, but I am not sure such spreads tell one anything other than, for example, if the Sprott-SLV spread rises too much then it’s time for Sprott to arbitrage it by buying more silver and selling more shares.
Tibor: I don’t disagree. I think that, at the end of the day, the gold:silver ratio will likely be below 25:1 and may reach 15:1. This gives silver 2X to 3X upside relative to gold. But there can be a lot of zigs and zags between now and the end of the day!
vp: my call for silver to fall is a short-term thing, over the long term it is the paper currencies which will fall. For my full long-term view, I refer you to my paper: http://keithweiner.posterous.com/gold-bonds-to-avert-financial-armageddon.
Let me rephrase;
“I remain unconvinced that these futures spreads are signalling anything but potential arbitrage opportunities for arbitrageurs”. Though personally, I don’t know there is a lot of difference in this day & age. How can bidding for gold futures, denominated as they are in $, give you a risk free opportunity? It’s like denying there could possibly be a problem with gold delivery.
I tend to agree with the Professor that the outside spreads are illiquid & not necessarily indicative of ‘monetary crisis’, the nearest future maybe more so. The fact that the vast majority of gold futures are either closed out or rolled makes me dubious of any real measure however.
I’ll also point out that Sprott & SLV are both fully ‘allocated’ funds, so it’s not a genuine comparison of the spread between an unallocated ‘gold’ account with a bullion bank & allocated gold.
The Perth Mint receives, maybe truckloads was an exaggeration but still significant amounts of gold & silver through its unallocated account in London. The Mint’s ask is then, more or less, set of off its bid for gold loco London.
I see the real deal as when the bid for allocated rises above the bid for unallocated. So far Bron says… no banana.
Professor: I agree that the distant futures have low liquidity and open interest. For example, while Dec 2013 has 8460 contracts open, Dec 2014 has 1276, Dec 2015 has 619, and Dec 2016 (which I just added to my graph when I saw backwardation disappear through Dec 2015) has 5 contracts open.
When I gave my presentation in Munich in August, I recall there was silver backwardation in 2013. When I gave an updated version of the presentation in Auckland at the end of November, the earliest backwardation was 2014. Since then, every day I looked and I saw it still there and then 2014 subsided. On Thursday, 2015 disappeared and so I added 2016 and it is not backwardated either.
To put it in perspective, the backwardation was 0.25% (annualized) prior to Thursday.
One other fact I can add to the discussion. The cobases of the near months have also been falling (and the bases have been rising). So this is not just a phenomenon of illiquid 2015 and 2016 contracts. The entire cobasis term curve moved down.
Here (http://i.imgur.com/zpbjF.png) is a graph of the Mar, May, and Dec 2012 silver bases and cobases. For both May and Dec 2012, the bases are at or near their highs, and the cobases are at their lows.
This means that relative to spot, the bids have been rising. Or looking at it the other way, relative to the futures, the bid on spot is weaker. Since gold has not been in backwardation (except for the occasional flicker of backwardation as a contract goes into expiration which is the “new normal”), I don’t read silver as a collapse in trust but more likely a duration mismatch in silver lending. And those who were mismatched have been working on the problem for a about a year, and on Thursday I think they fixed it. I intend to write another piece about this theory, stay tuned.
woww.. how to do that?? do we need warehouse? or oil tank for oil futures?