The Return of Gold Backwardation, and why Gold Suppresion will Fail
Central Bankers cannot prevail in war against gold - Jim Sinclair
A personal view on the latest machinations in the gold market from Tanzanian Royalty Exploration's Jim Sinclair.
Author: Jim Sinclair
Posted: Wednesday , 22 Apr 2009
The vast majority of those who read this site are fully aware of the shenanigans of the bullion banks over at the Comex and how they continue to bamboozle the hedge funds whose automaton-like response to momentum trading prevents them from beating this group at the paper game by standing for delivery in size. Additionally, their allegiance to system-trading and computer algorithms prevents them from thinking creatively and learning to take advantage of their enemies' tactics against them. Good traders learn to adapt to changing market conditions and modify their strategies when confronted by successive losses - the hedge funds, however, when it comes to gold, do no such thing.
Keep in mind that the name of the game in gold, as far as the monetary authorities are concerned, is deception. By artificially suppressing the price of gold, for much the same reason as the Fed has been artificially attempting to suppress long term interest rates by a deliberate policy of quantitative easing, the money lords hope to cloud the signals that free market prices would generate to the investing public.
Remember when gold prices first spiked above $1,000.00 and all the coverage that was received on both the financial cable shows and the internet news sites? That is the last thing any Western Central Banker wants to see because it is in effect a condemnation of the policies and practices that they have embarked upon. So what to do? Simple, confuse the issue and distort the signal by working over the gold price to dampen down any potential excitement, not to mention attempting to kill a rival.
When one looks at the present price at the Comex as of today and the short term technical chart pattern, it is not particularly encouraging for the bulls so you could say that Central Bank efforts in conjunction with their favored insiders at the bullion banks have been somewhat effective of recent weeks. However, there is one thing that no amount of market intervention and price manipulation can succeed in doing and that is in changing the basic structure of the futures market as evidenced by the relationship of the front month contracts to the later dated contracts.
In trading terms, we refer to the "spread" between the front month and a back month/months or the difference in price between the two, as a gauge of demand for that particular commodity. As a general rule, when the front month trades at a discount to the next month or to a later-dated month, the structure of that particular commodity futures market is normal or in contango. A market in contango will see those distant month contracts trading at enough of a premium to the front month to account for any storage charges, insurance against loss and interest rates. Simply put, a seller has to be recompensed for his/her expense in storing a commodity while they wait to sell it into the market at some point in the future.
Whenever a market begins to see this "spread" between the front month and the next month or more distant months begin to tighten or narrow, then something is beginning to change regarding the demand/supply picture in that particular commodity. Why is this? Because the market is ratcheting up the front month price and attempting to send a signal to potential sellers that demand is increasing and that they are better served by selling sooner rather than later. Economically speaking, the incentive to store the commodity, pay all those storage costs, insurance costs, etc, is not worth the increased cost that they might hope to receive at some point in the future. "Sell it to us now and we will pay you more for it than if you try to sell it later", is the message the market is sending.
When markets begin moving in this direction, narrowing the spread, they are said to be moving towards a condition known as, "backwardation". True backwardation occurs when the front month moves to a PREMIUM over the next month and particularly over the next set of three or four different contract months ( a note here - generally a market will not go into backwardation more than a few distant contracts out because it is assumed that the increased demand will result in increased production at some point and induce producers of that particular commodity to increase production on out into the more distant future bringing the demand/supply picture into more of an equilibrium. That will serve to bring the market back into a more normal structure of contango).
Backwardation is a powerful signal of very strong demand that is attempting to send a signal to the market that it needs more of that commodity to satisfy existing levels of demand. While market price manipulation can be somewhat effective short term for fogging signals generated from a rising price in gold for example, it is generally unable to affect the spread structure of the entire set of futures contracts listed on the board at any given time.
With this in mind, take a look at the April 09 Comex gold contract and its spread between the June 09 Comex gold contract. Notice the narrowing of the spread, or the move in the direction of backwardation. It is not there yet but the fact that this particular spread has narrowed so significantly is more than noteworthy. It is a mere $0.60 from moving into backwardation after having traded as wide as $6.50 at one point.
To show that it is not just an April/June phenomenon, but rather one that is beginning to characterize the structure market of the Comex gold contracts, please note that the EXACT same thing has been occurring in the April 09/Dec 09 Comex gold spread. It too has narrowed quite significantly.
While nothing is foolproof in this day and age of managed markets and official sector shenanigans, the timeless spread charts are telling us a story that even the best efforts (or worst efforts if you prefer) of the Western Central Bankers and their unending war on gold is drawing to a close in which their policies have all but ensured their defeat at the hands of the "barbarous relic". Short term they can win many battles but long term they cannot prevail in the war against gold.