The Contango – Just Another Dance Craze?

As many market observers have already addressed – some, like GATA, for many years – it is in the government’s interest to attempt to control precious metals pricing.  Just as with interest rates or currency exchange rates, gold and silver prices are an important benchmark of economic stability, market confidence, inflationary pressure, or the lack thereof.

At the present time, however, it’s becoming increasingly difficult for our economic witch-doctors to balance their continued easy monetary policy with low bond yields, a stable currency, low inflation expectations, and stable -even falling – gold prices.  As any good Austrian would contend, “just can’t happen”.  Not in the real world, and not for long. 

Left to run it’s course, our nation’s deficit spending and loose monetary policy would, necessarily result in a declining dollar as monetary creation outpaces production of goods and services.  Simple, right? 

And, normally, this should result in rising interest rates.  That’s mostly because the market naturally begins to anticipate inflation – or what they commonly think of as inflation, rising prices, etc.  But, in truth, there should also be a basic recognition that governments pump the monetary printing presses for one reason only, and that is to spend it before prices rise.  Borrow now, pay it all back with paper that’s worth less, err maybe worthless.

Well, in the current scenario, interest rates have been slow to rise, largely since (it might be imagined) the Fed itself is buying the government’s debt with the newly digitally minted money.  To the uninitiated, that is what used to be called “monetization” of the debt, but, so long as it stays well hidden, it’s just another sign that “deflation” has really taken hold. 

Never mind that the “market” isn’t getting overly close to the treasury auction bidding process.  Don’t bother showing up unless you’re already in a position that requires shoring up and preventing the kind of shock to the system that rapid rate escalation would cause.  And, believe you me, there are plenty of those kinds of buyers out there at the moment.  

As layed out plainly by Chris Martenson, this particular “shell game” is doing double duty and helping contain the currency part of the problem as well. 

Having the rate and currency elements “well in hand”, it would seem, that only leaves the “gold problem” to address, which – as you might already know – is somewhat more difficult for them to pull off.  Why?  Well, unlike the paper instruments noted above, there is actually a finite supply of gold in the world.  That, in a nutshell, is why it is more of a money than, say, our money is.  Which, again, is why it represents such a risk to the Keynesian nutjobs in Congress, the Whitehouse, the NY Times, and at the Fed’s printing presses. 

Given that fixed supply of physical gold, that only leaves paper gold to “manage”, and manage it they have, as noted in my last post.  But, recent revelations regarding the degree of paper leverage in the gold market aside, you can’t very well hide the rising tide of physical demand under the rug.  Well, not for long at any rate.

So long as the market anticipates that future supply will be adequately matched to that demand, you’ll tend to see “Contango” in the market, a slightly upward slope in the futures price as compared to today’s spot price.  Keep that intact and you’ve got measured, reasonable, rational market behavior.  Lose it and move into “backwardation”, where the market starts to place a premium on current delivery as compared to, say, uncertain future delivery, well then Martha, we got a problem.

As we know, gold prices have generally stayed high in this “deflationary crisis” and have continued to move higher over the course of “the recovery”.  As problematic as that might be to those who would like us to believe that inflation is only running at 1% or so, the real risk is that so-called “gold basis” may be shrinking. 

The gold basis, as studied by the likes of Antal E. Feket, is the difference between near-term futures prices and current spot.  (See his excellant work on the subject here.)  Tracking changes in this relationship can be a useful guide to future behavior in this critical “bench-market.”

Kept well on the positive side of the scale and the market is still dancing the Contango and likely to keep doing so.  When it goes negative, and stays negative, well it’s “Last Contango in New York” time.  Today, there is precious little contango remaining in the market.  Other commentators, such as Prof. Feket, have documented the shrinking contago in this market.  It remains to be seen whether the implicit delivery problems emerging from the recent CFTC hearings will push this over the edge, but it surely seems to be likely outcome.

And, so, for those who might recognize that “the Contango” of the past generation may be well be going the way of “the Twist”. “the Swim”, and “the Mashed Potato”, it might help to learn the newest, up and coming dance craze I like to call ” the Backwardation”, set appropriately (H/T Prof. Feket) to “Let’s Get Physical”.


Harry Tuttle


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