My expectation going forward from here is the gold forward rate is just one of these signals that there is a lot of stress in the (fractional reserve gold) system, and that the stress in the system is ultimately going to be met by higher gold prices, because it takes higher gold prices to entice people to get rid of their gold and accept a national currency in exchange. And it’s this physical gold (being) dis-hoarded from the above ground stock that ultimately relieves the pressure and the stress that we are now seeing in the LBMA system.
The LBMA site is reporting the gold forward rate as a negative, meaning that gold forward rates are higher than (U.S.) dollar interest rates. In theory, this isn't supposed to happen. Gold interest rates are always lower than dollar interest rates for one important reason: Physical gold cannot be created by bookkeeping entries.
A “shortage or tightness of supply” means that unless demand slackens or supply increases, the price must rise. Given the strong demand for physical gold at the moment, a decline in demand at current price levels seems unlikely.
In contrast to national currencies, the supply of which can be increased to any quantity by mere bookkeeping entries, physical gold comes from two sources – new mine production or the existing aboveground stock. But mine production is relatively fixed. As I explain in The Aboveground Gold Stock: Its Importance and Its Size, the aboveground stock of gold grows consistently year after year by 1.8% per annum, which is not rapid enough to satisfy current demand.
Consequently, the present “shortage or tightness of supply” of gold can only be relieved from its existing aboveground stock. The only way for that to happen is for the gold price to rise high enough to entice people to exchange their physical metal for dollars, which is what happened the last two times gold was backwardated.
In summary, when gold backwardated in 1999 and in 2008, it marked important lows and key turning points in the gold price, which thereafter began multi-year uptrends. I expect the same outcome to be repeated now given that gold is once again in backwardation.
James Turk came back on the show after a long haitus. He's extremely bullish on the yellow metal and for good reason. It's been going back up as of late and we're not seeing very much resistance on the upside. James is thinking that it will finish positive for the year and that this will be the 13th winner in a row. Perhaps he's a bit overly optimistic, but he's been right twelve years running and that's good enough for us. He's still seeing extremely powerful Asian buying, with China picking up Indian slack and we are heading into the strong gold buying season. Indian brides are happier when showered with gold.
Gold backwardation is an abnormal condition, but theory and practice are different things. It is extremely rare for gold to be in backwardation, but it does happen when governments intervene in the market process. In this regard, gold is different from crude oil, soybeans and all other commodities, any and all of which can be – and frequently are – in backwardation. Gold has an interest rate. Lumber, sugar, corn and all other commodities do not. Their “cost of carry” to determine their future price is based mainly on warehousing fees that need to be paid for their storage.
More to the point, gold is money because it is accumulated. Essentially all the gold mined throughout history exists in its aboveground stock, whereas commodities get consumed and disappear. They are not money, as I explain in The Aboveground Gold Stock: Its Importance and Its Size.
So while commodity backwardation is not a unique event, gold backwardation is rare. Even though gold backwardation cannot happen in theory, it does occur when government intervention loses its desired effect, meaning that market forces are overpowering government attempts at manipulation.
Until now gold backwardation has only happened two times since this bull market in gold began back in 1999, and each prior occurrence lasted only a few days. In both instances market forces briefly overpowered government interventions aimed at manipulating interest rates. So gold backwardation does occasionally occur in spite of government intervention because central banks cannot “print” physical gold to alleviate demand pressures.
Market forces overpowering central bank manipulation can explain what is now happening in gold. The US government does not want gold to go into backwardation because it means that people would rather hold physical gold than dollars, which undermines the power that comes with being the world’s reserve currency. But as we can see in the following table that presents the US dollar spot gold price and forwards against gold, market forces are prevailing to some extent over the Federal Reserve’s attempts to control interest rates.
The answer is straightforward. Interest rates are a reflection of risk. The interest rate structure in the above table implies that the pound has a higher interest rate because it is more likely to be debased by government and central bank policy (i.e., lose purchasing power) than the dollar, which itself is more likely to be debased than the euro. Carrying this concept one step further, the pound is in contango (as are the dollar and euro) against the Indian rupee and South African rand for example, both of which have higher interest rates than the pound because they have a greater risk of being debased by government and central bank mismanagement.
However, the interest rates of all national currencies need to be viewed cautiously. As Chris Powell of GATA.org famously declared in 2008: “There are no markets anymore, just interventions.” So rather than being a reflection of true market conditions, interest rates today result from heavy-handed central bank manipulations, thwarting real and accurate price discovery by the market.
- James Turk via a recent GoldMoney article, read the full article here: