Backwardation, The Bank Of England And Falling Prices - Bron Suchecki

Discussion in 'General Precious Metals Discussion' started by ozcopper, Mar 29, 2018.

  1. ozcopper

    ozcopper Administrator Staff Member

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    Backwardation, The Bank Of England And Falling Prices
    Bron Suchecki

    In commodity markets backwardation is an indicator of physical shortages. Shortages result in buyers bidding up the cash price of the commodity above the future prices. This creates a profitable trade (called decarry) for those holding the physical commodity – they can sell it now and buy a futures contract at a lower price, locking in a profit.

    Backwardation should therefore be associated with rising prices. However, in a recent Macro Voice podcast, guest Jeffrey Snider noted the anomalous situation in the gold market between 2013 and 2016 where negative gold forward rates (GOFO) indicated backwardation while the gold price was falling. Jeffery’s chart below shows periods where the LBMA GOFO rate was below zero, along with the Bank of England’s custody holdings (gold held on behalf of central banks and bullion banks).

    [​IMG]

    Jeffery sees this unusual situation being related to the Eurodollar market:

    “Whenever I see the forward rate go negative, and we see gold disappear from official stores, that tells us that there is a funding problem, a collateral problem, in these global Eurodollar markets.”

    Unfortunately, Jeffery’s chart stops at January 2015, as the LBMA discontinued publishing GOFO due to increasing regulatory costs associated with operating a benchmark. Fortunately, Monetary Metals has developed MM GOFO™, a market-derived replacement rate with a very high correlation to the historical LBMA GOFO.

    The chart below shows the Bank of England holdings along with the gold held by the US ETF GLD against the times the MM GOFO 3m rate is below zero.

    [​IMG]

    The first time MM GOFO goes negative is April 12, 2013 and again on the 23rd but it is not until mid-May that the rate moves into solid negative territory. It is as this point that a significant amount of gold at the Bank of England starts to be withdrawn. When MM GOFO returns to positive in mid-2014, the Bank of England holdings stabilize but then fall again once MM GOFO drops below zero for the second time.

    It is only after MM GOFO rises and stays above zero that gold returns back to the Bank of England. Similar behavior is also exhibited with the holdings of GLD, including the pause in mid-2014. Over the three year period approximately 1,600 tonnes were withdrawn from the Bank of England and 650 tonnes from GLD.

    Where did all that metal go? For the three year 2013 to 2015 the UK net exported 2,385 tonnes, with the largest recipient being Switzerland for re-refining and eventual shipment to Asia.

    [​IMG]

    This period is of particular interest to gold investors because it was in April 2013 that the gold price broke support levels and crashed from the $1600s to below $1300, all the while there was booming demand from Asia. The chart below shows this time period, comparing the gold price to MM GOFO. It cannot be coincidental that MM GOFO first moved below zero, and Bank of England withdrawals picked up speed, in April as well.

    [​IMG]

    In hindsight, both the gold price and MM GOFO had their last peak in October 2012 before rolling over with GLD and Bank of England holdings peaking later in December 2012 and February 2013, respectively.

    While we do not discount the impact of the Eurodollar funding/collateral issues Jeffery identifies, we consider the fact that forward rates were falling along with the price as indicative of another dynamic in play. Regular readers may get a hint when we note that forward rates are another way of looking at a topic we discuss every week in our Supply and Demand reports – the basis and cobasis.

    For a forward rate (or basis) to fall, it means that the difference between futures prices and spot prices must be getting smaller. In commodity markets, this manifests as the spot price being bid up faster than the rate at which futures prices are also rising, closing the gap to futures. Eventually spot moves above futures, resulting in backwardation.

    However, in the case of gold, the fact that the stock of gold above ground is equal to over 60 years’ worth of mine production means that gold is not a typical commodity and cannot really ever be in shortage.

    In the case of 2013, the falling forward (basis) rate indicated that it was futures prices which were falling faster than spot, closing the gap, until futures fell below spot, giving us negative MM GOFO. The driver for this behavior is the leverage inherent in futures contracts: futures traders are under more pressure to liquidate positions once they move against them than those holding fully paid physical (spot) gold.

    As we see in the chart above, while forward rates were positive they were in a falling trend from late 2012 onwards. Positive forward rates mean it is profitable to carry gold – buying physical gold at spot, storing (or carrying it) and selling a futures contract against it at a higher price – but this profit was declining into early 2013.

    Once rates moved below zero in April 2013, the market moved into a situation where decarry became profitable. Thus bullion banks with physical gold at the Bank of England were incentivized to sell that gold in the spot market and buy it back at a lower price, via futures or forward purchases (from a mining company, for example).

    This decarry pressure remained until early 2016 when the gold market bottomed and forward rates began to rise on the back of resurgent dollar interest rates, shifting the market back to the more normal contango state where the incentive was to carry gold. It is no surprise that stocks of gold held at the Bank of England recovered at this time, increasing by 600 tonnes.

    Bron Suchecki

    © 2018 Monetary Metals
     
  2. mmm....shiney!

    mmm....shiney! Well-Known Member Silver Stacker

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    Great article, thanks Oz and Bron. And here I was thinking it was because JP Morgan and Deutsche Bank manipulated the price of gold.

    Not. :D
     
  3. bron.suchecki

    bron.suchecki Member

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    It will be interesting to see if the BoE stocks keep on rising back to their 2013 peak with this high GOFO showing no signs of coming off (driven by rising LIBOR).
     
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  4. Fraser

    Fraser Active Member

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    Once again Bron, I take issue with your interpretation. Just like your article with Dr Tom Fischer, when your claimed that Prof Antal Fekete was a "pseudo expert" and that backwardation had no economic meaning. Is not the simple reality in this case that [1] the gold price fell into 2016 as the Bank of England liquidated its gold holdings and [2] the gold price rose after London stopped liquidating (manipulating the gold price lower)?
     
    Last edited: Mar 30, 2018
  5. bron.suchecki

    bron.suchecki Member

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    What article with Dr Fischer are you referring to? Regarding [1] those figures are not the BoE's metal, that is metal is hold as custodian for others, it was others that were liquidating it. If the gold price fall was instigated (ie the primary driver) by people selling their gold held at the BoE then spot would have fallen faster that futures and thus the basis would have risen. This is not what we see, it is the basis falling which means futures were falling faster, highly indicative that that was the driving force with spot trading (selling) following.
     
  6. Fraser

    Fraser Active Member

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    https://safehaven.com/article/32144/gofo---real-explanations-vs-pseudo-experts

    - which was refuted at length by my article :

    http://www.ferret.com.au/articles/i...ion-may-cause-a-new-financial-crisis-n2518940

    The point is, you can't go around calling a hero of mine (Prof Antal Fekete) a "psuedo-expert", particularly when he is right and you are wrong!

    In short, backwardation is the the result of tightness in supply of physical, which creates an arbitrage opportunity for the bullion banks to sell physical and buy futures. But suppose the backwardation becomes established, then the arbitrage cannot be easily unwound at a profit. To manage this position, the bullion banks sell ever more physical and buy paper hoping to get the market back into contango. Markets (like COMEX) are thereby drained of physical and fill up with paper (just like we see today).

    The final stage (as correctly described by Fekete) is a "permanent backwardation", when physical never returns to the market and a delivery fault becomes inevitable. The backwardation then gets VERY large, to the point that no amount of dollars can entice physical back into the market. At that point we get hyperinflation and a "currency reset". All of which was acurately forecast by Fekete and (for some unknown reason) disparaged by you.
     
    Last edited: Mar 30, 2018
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  7. wrcmad

    wrcmad Well-Known Member Silver Stacker

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    Bron has way more credibility than you and your buddies. Fcuk, even a hack like me has shown your articles to be inaccurate.... and you go and publish them anyway and claim expert status. :rolleyes:
    With amateur statements like this, outlining a supposed proof based on nothing but an outrageous statement, it is easy to tell who is educated and who is not:

    "...my actual proof for the existence of an arbitrage rest with the fact that without a guaranteed return, the banks would not be in the business in the first place and would not have subsequently made profits every day for years on end without a single loss. And yet they are and they do, so QED – there is an arbitrage!... " - link

    Bron has a complete understanding of the workings of the market and backs up his explanation with numbers and facts, instead of fabricating so-called "proofs" with a fantasy mind-set, and thus gets my vote every day of the week.
     
  8. bron.suchecki

    bron.suchecki Member

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    Fraser, that article you link to is by Dr Fisher, not me, nor is it co-authored with me. I ask you again, where is an article where I have called Fekete a "psuedo-expert". I have been following Fekete's work ever since I saw him in Canberra in 2008 at the Gold Standard University Live conference https://goldchat.blogspot.com.au/2008/11/gsul.html and don't consider him a psuedo-expert.

    Here is a post https://goldchat.blogspot.com.au/2010/07/degrees-of-distrust.html about a presentation I gave at Gold Standard University Live conference in 2009 proposing four phases on the way to permanent backwardation. I also wrote a few posts about Dr Fisher ideas around that time, see https://goldchat.blogspot.com.au/2013/09/faux-gold-arbitrage.html for example.
     
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  9. Fraser

    Fraser Active Member

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    Apologies Bron, but in the original article you were mentioned by Dr Fischer as a leading contributor. Around that time, I remember discussing with you my strong objections, not only to calling Prof Fekete names, but also the logical flaw in the article, namely that it only restated (not proved) its own assumptions. Reading the (latest posting of that) article now, I cannot find you as a contributor. Whether or not you withdrew support purposefully, I commend your withdrawal of support now.

    Coming back to your article (above), notice that during the period of negative GOFO (2013 to 2016), the markets behaved as Fekete predicted, namely physical was sold and paper was bought.
    This has both reduced physical gold holdings and expanded the Open Interest on (for example) COMEX, to the point that the market is now (possibly) vulnerable to a default. This last point may (or may not) overstate the current situation, but the trend is there and so what Fekete was banging on about is (I think) gradually unfolding.
     
    Last edited: Mar 31, 2018
  10. Ipv6Ready

    Ipv6Ready Well-Known Member Silver Stacker

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    Should look at this from the view that there is a glut of gold but with a big pent up demand for gold at lower prices.

    Every other commodity be it, coal, iron or grain with 60 years supply will be worth less than ZERO. the artificially high gold prices is due to inefficient use of gold by private and national bullion holdings, which suppress the demand due to high prices for the biggest effcient gold market the jewllery sector.
     
  11. bron.suchecki

    bron.suchecki Member

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    Fraser, do you have a link to this "original article" where I was a contributor? You are stating it as a fact that I was a leading contributor. I do not remember ever co-authoring articles with Dr Fischer or anyone else, maybe you have confused Fischer referencing/linking to something I've written as co-authoring. I certainly did never or would not be calling Fekete names. And I certainly never retrospectively edit anything I've written. To say I'm withdrawing my support now is saying I lack integrity and sneak around editing the historical record, a grave accusation. Dr Fischer's articles would have been syndicated and preserved in https://archive.org/web/ and you should be able to find where I called Fekete a "psuedo-expert".
     
  12. Fraser

    Fraser Active Member

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    Bron, I can only produce the reference that was in my article refuting Fischer's:
    [2] Dr Tom Fischer “gofo – real explanations vs pseudo experts”
    http://www.safehaven.com/article/32250/gofo-real-explanations-vs-pseudo-experts
    Which (despite retaining the correct heading) now appears to link to something else.

    The only other thing I can say is that you were definitely listed as a "leading contributor"...
    Otherwise I would never have cause to mention you in my refuting article.
    And please note that I have never stated, not then (nor now) that you were a "co-author", as you claim.
    Not that it means anything, but you do appear in Fischer's references.
    And in our telephone conversations you did say you "helped" him with the article.

    I can only suggest we contact Tom Fischer to resolve the matter.
    Last known posting is Professor of Financial Mathematics at the University of Wuerzburg, Germany.
    I will try to get in contact with him next week - because I too want this matter between us resolved.
    I can offer no further explanation, nor suggest any way forward other than that...

    All that said, I can fully accept that any help you gave Dr Fischer may have been purely technical, without any knowledge of Fischer's attack on Fekete.
    But please understand my annoyance towards anyone who attacks the legends in our field of enquiry.
    Right or wrong, there is just no call for it and (as we both agree) calling Fekete a "psuedo-expert" is just plain BS.

    PS> Actually, I may be able to resolve the matter myself, because I still have all my old emails (including our correspondence) on an old computer.
    Give me a couple of days...
     
    Last edited: Apr 1, 2018
  13. bron.suchecki

    bron.suchecki Member

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    "any help you gave Dr Fischer may have been purely technical" that is the point. I talk to a lot of people, provide comments and they can say that I've spoken to them or helped them, and even if I knew what they are going to say about Fekete, I can't stop them and that does not mean that I am responsible for what they write.
     
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  14. wrcmad

    wrcmad Well-Known Member Silver Stacker

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    [​IMG]
     
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  15. Fraser

    Fraser Active Member

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    Bron - totally agreed.
    I am also very sorry to open old wounds - please forgive me.
    I have raged over this silly article for way too long and life is too short.
    My own advancing years have obviously made me lose perspective of what is important.
    I sincerely apologize whole-heatedly and forgive me.

    I liked your article (above) and it has prompted me to revisit the subject.
    In my personal opinion, I think you are well on track but have stopped half-way.
    Because I think that "backwardation" does not end until GOFO > LIBOR (see my article).
    And with LIBOR now soaring, we are not done yet!
    Theoretically of course, "backwardation" should never occur and yet here we are since 2013!
    It appears (to me) that the physical is just not available to get the market back into contango.
    And with the paper Open Interest on COMEX ever rising, I can only see the situation getting worse.
    While some countries (like Canada) have chosen to just let their leased gold go, others like Hungary are demanding repatriation of what is left.
    Where and when this ends - no idea - but Fekete's "permanent backwardation" looks about right to me!

    PS> For what it's worth, I also think the current geopolitical situation is related.
     
    Last edited: Apr 1, 2018
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  16. wrcmad

    wrcmad Well-Known Member Silver Stacker

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    All BS.
    Gold is not in backwardation, and not in short supply.
    I notice you are ignoring me.
    That is what the other permabulls did after I gave them this explanation :p: Gold not in backwardation
    .
     
  17. bron.suchecki

    bron.suchecki Member

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    While LBMA stopped publishing GOFO, Monetary Metals has been able to reconstruct it with a high degree of correlation to the LBMA figures. Based on our latest figures https://monetary-metals.com/data-science-charts/gold-forward-rates/ gold is not in backwardation and is currently sitting just under 2%.

    At the moment, we are only in what I consider the 2nd Phase, where we see occassional backwardation which comes and goes and it usually only as the futures contracts approach first notice day and expiry. We won't suddenly jump to permanent backwardation, first I think it would show as more backwardation periods, prolonged and not just in shorter maturities but maybe 3 month durations going to small backwardation. As people lose confidence, then backwardation will start to persist in shorter maturities, increasing to longer maturities. Balances in ETFs, Comex and other holdings will decline as gold is being pulled and stored outside the system. We are well away from that at this time.
     
  18. JOHNLGALT

    JOHNLGALT Active Member

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    I can understand why people would be ignoring you, especially when you call them permabulls & permatards.
    Maybe if you do a bit of study & don't keep TROLLing your better, more educated posters they might listen to you.
    However I think that it may take many years to get to a level where you will get any respect.(from what I've seen of your contribution). _JLG.

     
  19. wrcmad

    wrcmad Well-Known Member Silver Stacker

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    I’ve done my study, and again, the questions got too hard for Fraser, so it’s easier for him to ignore than to discuss. Very questionable that he is more educated.... if that was the case, I’d be cannon fodder for him. ;)
    While he ignores, you lean on the Troll tag - same dismissive tactic when things get too hard. :p
     

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