Bill Gross’s tweet on Friday, “Gross: Pogo said, We have met the enemy & he is us. I say, All asset mkts peaking; W/o central bank ck writing we only have ourselves 2sell2” pretty much sums it all up…and if you really think about it, Gross explains in one sentence that it is all a Ponzi scheme. “We only have ourselves 2sell2.” Isn’t this the way Ponzi schemes end? When the “money” stops coming in it’s all over…which is exactly what he says here “without central bank check writing”…
As I read the above tweet I thought that it was the big news for over the weekend. I was wrong. I then heard that Russia is stepping up to support Egypt’s military…right after we have suspended aid. Yes there is danger that shipping gets crimped with uncertainty over the Suez canal but more importantly this puts us directly at odds AGAIN (Syria) in the Middle East with Russia. I don’t want to get into the politics of what is right or who is wrong but we are not sending clear signals of where we stand and whether we will actually back our stance with any muscle. This is a show of weakness and just as in the animal kingdom, the perception of weakness brings on predators.
While the above two stories (amongst others) are important, the big news is “a measly .70 cents”…let me explain. On Friday we had the August gold contract close .70 cents above the December contract. This is backwardation. Previously for the last month we have had a “negative basis” in London for the gold forward rates. Similar, but not exactly the same. This has now lasted for a full 30 days.
Theoretically this (backwardation) cannot happen in gold because it is “money” rather than a commodity. It has stable supply growth and gold today should never be worth more than gold 4 months from now. Basically gold for future delivery should “cost” more and is a basic function of interest to be earned over that time. Is this just an anomaly? Will it persist time-wise? Yes, it definitely is an anomaly and as I mentioned, it should NEVER happen. Will it last any length of time? It really shouldn’t because it should be arbitraged out but my guess is that there is a good chance the backwardation gets deeper and then becomes an emotional event.
When I say “emotional,” this is what it’s all about because mathematically gold today cannot be worth more than future gold…except in one instance. Gold “in hand” may become more valuable than future gold if, and ONLY if the market believes or fears that they will not be able to get their gold in the future. When you purchase an option, future or OTC derivative that “promises” you gold at a price and date in the future you have to have “trust” that the issuer of the promise can and will perform (deliver the gold). If or when this “trust” fails or breaks down you get this situation where the mentality is “I want it, and I want it now!”…and thus current gold more valuable than gold delivered in the future (or not?).
To me it is not surprising that gold futures have finally backwardated. We have seen all sorts of oddities this year. We have seen price go down accompanied by massive demand and delivery delays because of shortages. We have seen vault inventories eaten away. Germany was told that they could not repatriate their gold from the Federal Reserve while publicly the story was “It’s just so much gold that it will take 7 years to ship it all.” (BOGUS answer!) We have seen “vault fires” (I wonder what was so flammable?) and now JP Morgan plans to sell the Chase Manhattan building which houses the world’s largest vault.
Many of these various oddities by themselves might be “explained” away (maybe) but collectively they are creating TOO MUCH smoke for there not to be a fire somewhere (everywhere). It is this “smoke” which is spooking investors into the “I want it and I want it now” mode. Remember we live in a “fiat” world where confidence is not only everything it is the ONLY thing that holds the system together.
I want you to ask yourself a few questions. If it turned out that inventory data turned out to be false or if gold held by the Federal Reserve for other nations turned out not to be there, what would the ramifications be? What would happen if the gold in Ft. Knox isn’t there and the world found out factually and publicly? What would happen to our bonds and interest rates? How would it affect our ability to borrow? What would it mean for the “value” of the dollar? What or how many more dollars would it take to buy a gallon of gas or a dozen eggs? How would trade be affected (or from our point of view even “effected”)?
These are all big questions. It will be important to keep your eye on whether or not the backwardation in gold persists or inverts further. I know that currently it is only 70 cents. It should never ever be even 1 penny. With inventories bled down as they are, further backwardation could become a self-fulfilling prophecy where a panic gets larger and spreads simply because a panic got started in the first place. I have said this many times before, “Confidence is a funny and fragile animal. It is easy to lose and once lost very hard to get back.”