There are certainly a lot of dramatic symptoms telling us our economy is currently in unusually dire straights. Not the least of which is the news on Tuesday that Fed Chairman, Ben Bernanke, has lower the Fed's fund rate to it's all time lowest [evah]: 0.0 - 0.25%. That apparently surprised economists, but seems to have pleased Wall Street.
It's hard for (really) anyone to know what to make of the myriad individual signs and symptoms of our crippled economy. There are just so many signs, stacking on top of one another, all seem to be pointing in a pretty ugly direction - that it's hard to pick out just one to talk about.
Of the list of symptoms that caught my eye in the past few days (see below in comments), one kind of stood out from the others: gold backwardation. It's what Antal Fekete, of Asia Times Online, calls "the last contango of Washington".
Kind of catchy, but I like to broaden it out. I prefer... "the last contango of Backwardsland".
[Now... whether it's really the last contango, that is yet to be seen. That seems kind of (... what's the word?) dramatic to make so bold a statement. My intention is not to make that statement myself, or reinforce Fekete's views [or any other], but rather to begin exploring the concept a bit. I'm not an expert of any kind, so I am loathe to prognosticate. This diary is not an attempt at prognostication. It is for purely explorationary-informational-google-tubes's kind of learning. Please don't consider anything I say as fact without checking it out for yourself. By the way, if you are one of those folks who is totally frustrated by diaries that explore ideas, but never reach conclusions... look away. This diary is not for you. ;0)]
First I suppose I should offer a few definitions. "Backwardsland" is my term for the condition of reality we are/have been living in here in the US of A [and probably most of the world] in which the powers that be have manipulated the trust of the masses to the point that we really have no idea what's going on or who to trust. Being manipulated by those we trust has the effect of deadening our intuition because when we just aren't willing to believe the worst could possibly be true - that someone we trust could be bold-faced lying to us - we don't listen to our intuition, and it turn, it stops 'talking' to us. It stops raising the red flags and giving us those gut feelings(etc.) at just the right time to give us a clue as to what's the truth of any given situation. And when our intuition is completely cut off, or even just impaired, we are even more susceptible to being manipulated. It's a win-win for the bad guys. Backwardsland is a constant state of misinformation that results in having to relearn who to trust, and regain our inner bearings.
Bernie Made-off is the prime example of Backwardsland royalty. Marc Dreier is pretty much the same, only different by degree. So that's Backwardsland. What's contango?
Contango is the market condition in which the value of a resource (commodity, bond, currency) is worth more in the future (based on futures contracts) than it's worth today; and more in the long term future than in the near term future. Basically, it's value is continuing to rise. This is not to be confused with inflation, which is a broader indicator of the over-all, long-term direction of consumer prices. Contango refers to the rising of specific investor pricing, on specific future dates. If the futures prices are rising, they're in contango.
Backwardation, on the other hand, is the market condition in which a resource futures price is valued more in the near term than it is in the far term. Basically it's future value is expected to be less than what you can buy it for today based on contracts already signed. Likewise, backwardation is not to be confused with deflation. Although there is a potential for prolongued backwardation to cause deflation.
It is easy to see that when a raw material begins to cost less, the follow-through in the real economy is deflationary. Prices falling to the investor translates as prices falling to the consumer. The exception to this rule is gold. The reason is that gold (at the macro-level) is not like normal commodities that are purchased to be used (oil, wheat, wood, etc.) by the consumer.
Gold is a commodity that does not decrease in supply simply by being bought and sold. That's because it's primary use - at the macro-level - is for accumulation, aka hoarding, aka reserves, aka collateral. Basically, you can sell the same gold over and over for generations or you can keep it forever. But you sell 'for consumption' commodities just as many times as it takes to use them up - that could be one and done, or it could be multiple times. But it's eventually gone. For gold, in some cases the same gold has been hoarded kept as reserves around the planet for thousands of years without depletion.
So what this means is that if future prices of gold are falling that future discount may not necessarily be realized by anyone. Since the natural use of gold is for hoarding, the drop in price may in fact cause an amplification of hoarding as sellers refuse to take a loss, preferring to wait for a later date to sell... whenever that may be, perhaps after the current crop of contracts expire. Again the question of 'when the market turns?' becomes key.
According to James Turk, of marketoracle.co.uk:
The contango is gold's interest rate.
Basically this means that when people invest in gold the continual rising of it's futures price is, in effect, the interest rate that gold earns. When the price rises, you earned money just by holding the gold. Conversely, when the price falls - on paper you lost money, even though you have the same exact amount of gold.
Although backwardation is quite common among commodities purchased 'for consumption', according to Turk, it has only occurred three times since the 1970's with gold:
The first occurrence was November 29, 1995. That backwardation lasted for a day and was probably the result of a hedge buy-back by Barrick Gold completed then (one was announced by it shortly thereafter).
The next occurrence lasted for two days, September 29-30, 1999, after several central banks announced the Washington Agreement on Gold. That accord set off a mad rush for physical gold to cover short positions in the wake of the price surge triggered by their announcement.
The third occurrence happened last month, and continued for three business days, November 20, 21 and 24 [2008]. There was not any apparent event triggering this latest backwardation as there was with the two previous occurrences. But it probably reflects the exceptionally strong demand recently for physical metal. **
Turk goes on to suggest that there are two possible reasons why this recent gold backwardation my have occurred. The first of which is that there is possibly a premium added to the spot price of gold. Which is another way of saying that the market believes the current value of gold is higher than the on-going contracts have them priced at.
The second possible answer is more ominous. If gold does trade in backwardation against US dollar for a protracted period (again, barring a very short-term and ephemeral event like the first two instances noted above in which a temporary demand for physical gold disrupts normal market activity), it will mean that a collapse of the dollar has begun. Think about it. How could gold go into backwardation for any prolonged period? If it does, it would mean that no one is willing to take the risk of selling their hoard and instead hold US dollars. It would mean that no one is willing to accept the risks that come with holding dollars while waiting until they can be used at a future date to exchange back into gold. *same*
So now, all this seems a little extreme. But under the current circumstances in which we are being bombarded daily with ongoing bits of extreme news... Well, let's say it's worth us keeping our eyes on.
Just to get a bit of a grip on it... This was only a three day backwardation of gold that was experienced last month. Clearly, it would seem we are now back to a more regular condition of contango, but how long is that to last is the the question Antal Fekete raises. Fekete among others, believes that contango is not to be the future gold standard. Although he comes off a bit as having some tin-foil in his theories, I'm not willing to outright dismiss an argument because it seems far-fetched. That's pretty much what got us where we are. (ie, No one could have known.)
[Caveat: There does seem to be a bit of dialectic between Fekete and the person, Mish, he mentions in the column. Mish calls Fekete out on his dramatic use of hyperbole. Fekete deserves that - he's way over the top. I have other reasons to be skeptical of Mish's comments about gold backwardation, mainly that he seems to be focused a little too micro. As well as...Not everyone who believes in the existence of the 'Amero' is a whack job. Just sayin.
On the other hand... Fekete does not seem to have the information that Turk has about the November 2008 three-day gold backwardation, nor the two gold backwardation events in the late 1990's. So there seems to be a montage of differing views on the history and meaning of all this.]
What really struck me about Fekete's article is his discussion of a later gold backwardation than the ones adressed by Turk. According to Fekete, there was a fourth gold backwardation just this month. According to him it occurred over a period of 8 days, beginning December 2, and ending on December 10 of 2008.
The reason Fekete believes this is a particulary important sign is, for one, that the gold contango is a indicator of the faith and trust in the US dollar, or lack thereof when contango turns to backwardation. And that (again, according to him) previous backwardations have been resolved within a single gold futures contract period. Apparently this most recent gold backwardation was the first to crossover to future futures.
The backwardation continued and worsened on December 8, 9, and 10, as shown by the corresponding rates widening to 3.5% and 0.65%. It is nothing short of awesome.
Already there was a slight backwardation in gold at the expiry of a previous active contract month [perhaps referring to the Nov 2008 backwardation], but it never spilled over to the next active contract month, as it does now: backwardation in the December contract is spilling over to the February contract, which at last reading was 0.36%. Silver is also in backwardation, with the discount on silver futures being about twice that on gold futures.
This is a premonition of a coming gold fever of unprecedented dimensions that will overwhelm the world as soon as its significance is fully digested by the doubting Thomases.
So take that for what it's worth. Stuff is changing in the gold futures market and at least a few economists think it's pretty serious. I tend to agree, although I don't yet have all the answers. Of course I've barely scratched the surface here on exploring what all this means, but I figure I/we can only benefit by doing so. (And I've got to start somewhere, so here we are. ;0) More on the subject is sure to unfold in a matter of due course. Like all things, either it will be shown to be something significant, or it won't. In the meantime... move along folks, nothing to see here.
Your thoughts and comments on gold and specifically gold backwardation are much appreciated. I'll be away from the computer for a while. But I will read, and if prompted, reply to all comments.
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And that brings me to my next segment... Macro-meta econ updates in comments. [Silly me, backwardation of diaries. Can you see why the concept caught my attention?] It's a lot of news to digest. Hang in there people. Peace.
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Just for a few hoots. [I love editorial cartoons, yo.]:
Underperforming math groups
As if we didn't already know
Some people will sell anything
And lastly... Never overestimate your position, nor underestimate your foe.
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UPDATE Feb 17, 2009: Gold has become the second reserve currency. Gold comments start half way (about 1.5 minutes) into the video.
Paraphrase: The gold action is making people crazy because currently gold is strengthening while the dollar is strengthening - that is so atypical.