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Gold Backwardation – The Real Story

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The Gold backwardation has been distorted as all sorts of reasons for everything. Normally, this is the market condition wherein the price of a forward or futures contract is trading below the expected spot price at contract maturity. Consequently, the resulting futures or forward curve is “inverted” whereby it is negative because gold is trading at even lower prices. This is simply driven by interest rates.

The typical explanation for the backwardation that is given states that it is normally a signal of a shortage in a commodity. They claim that anyone holding the commodity could make a risk-free profit by delivering it and getting it back later at a cheaper price because of the inverted yield curve. The theory is that as people put on the trade this would push down the bid in the spot market and lift up the asking price in the futures market until the backwardation disappeared. This process is called arbitraging that spread. Consequently, since the backwardation is simply a shortage in the immediate supply, the arbitrage stimulates production and the shortage is corrected.


Gold is by no means in shortage. Its primary use is investment and jewelry. Gold has historically been a glut on the market and at times it has been scarce. During the 19th century, gold became very common with the California, Australian, and Alaska discoveries. The US$20 gold coin production began with the California discover in 1849. This is why the silver-gold ratio fluctuates. Toward the fall of Rome, silver was scarce and the only coinage produced in quantity was gold. Then gold vanishes in the 7th century and does not appear again until the 13th century. The Spanish discovery of America brought back so much gold and silver, Europe went into a major inflationary period and the two metals declined with inflation insofar as purchasing power was concerned. Hence, comments that claim the price of gold does not decline, no matter how much of the stuff is produced, is just not true.

The story told is by definition assumes that gold delivered to the market must be in short supply. Therefore, they argue that such a situation is resolved only by higher prices. The assumption is that gold will rise in price because of this backwardation that took place for the first recent time in December 2008. They argue that Gold was $750 on December 5, but it rocketed to $920 – a gain of 23% – by the end of January. This was simply a flight to quality that saw money also pour into government paper. It was not a collapse in the faith of money or government. It was uncertainty.

They further claim that the Gold backwardation has become permanent and therefore the “trust” in the gold futures market will have collapsed. The reason they claim there is a significant backwardation shows that people did not believe in paper gold. This has been turned into people don’t believe that paper futures will be honored in gold. Further proof they claim is that backwardation should not be able to happen at all as gold is so abundant. Therefore, it must be the erosion of faith in paper money. Sorry! this is a lot of assumption that amounts to sophistry.

Reality Check

Now let’s talk reality. The Gold backwardation is simply nothing more than the collapse in interest rates as capital lost faith in banks and then the Sovereign Debt Crisis began with Greece in 2010. Much of the liquidity that came to gold in the early years was OPEC money. It had absolutely nothing to do with gold. The problem was OPEC was getting all this cash, but religiously they could not earn interest. Thus, I took clients and showed them if we bought gold and sold it forward we were earning the effective interest rate but it was called the “carrying cost”. Backwardation in this case is not indicative of any shortage whatsoever or a collapse in “trust” of the dollar. The dollar has been rising! Just look at German interest rates on short-term paper went negative by 0.6%. This has NOTHING to do with fiat and people losing faith in paper money –yada, yada, yada. If that were true, interest rates would not COLLAPSE, they would SOAR because people would not trust government bonds and they would have to pay up. The flight to quality would reverse into PRIVATE assets as it did even during the German Hyperinflation.

Backwardation in gold is a money issue and it is simply the yield curve – nothing more. It has gone negative just as US government T-Bills went negative. If the “carrying cost” of gold was 500% higher than the 90 day paper interest rates, then you have a guaranteed trade by selling the forward and collecting that premium over the 90 day rate. Professionals arbitraged that and thus the “carrying cost” must collapse to be even with interest rates or there would be a endless guaranteed trade.

This has absolutely nothing to do with anything. The stories posted are astonishing. If they were remotely true, then you would see the same trend emerge everywhere and interest rates would rise if people did not “trust” paper dollars and government debt. There are many people pontificating nonsense that is just gibberish. This sophistry is getting people to buy gold for the wrong reason and risks only their sale when they figure out the story is just bullshit.

Gold is a tangible store of wealth to make the transition from the present to the future monetary system. It is not going to $30,000 creating false images of getting rich quick. It is not that “fiat” money always collapses – it does not. If you were waiting for the end of the dollar since 1971, that is more than half your lifetime. Asia has had nothing but fiat monetary systems where the emperor, the hand of God on earth, simply issued a bronze or iron coin and said this is valued at – w,y,z. Regardless of what money has been, it is ALWAYS a confidence game.

Buy gold because it is an INSURANCE policy against the transition. It is distinguished because it is MOVABLE, from classes such as real estate that are IMMOVABLE. The problem emerging with gold is government is out to track every ounce and tax any sale. They are trying to eradicate the underground economy. That does not mean they will succeed. It also means they will try.

You will NOT trust gold if you are lied to. This has become a used car salesman spinning all sorts of nonsense just to make the sale. We all know something is wrong. It has nothing to do with what is money. It is all about fiscal mismanagement.

(1) Gold declined from 1980 into 1999 and all these fundamental stories were still there. (2) Gold rose into 1980 without backwardation.(3) We had a Gold Standard under Bretton Woods in 1945 and it collapsed in 1971 precisely in 26 years as always! It was the fiscal mismanagement and the fact money was backed by gold then meant absolutely nothing.