Something Shocking Has Occurred In The Gold Market

Turk:  “There are two major events underway which everybody should be paying close attention, Eric.  The first one is rising interest rates.  You and I have already focused on this point to some extent, but we saw another huge surge in rates to a new multi-year high after the unemployment report on Friday, which is very telling.  We need to look at this rise in interest rates in relation to an economy that is barely crawling along.

Here we are nearly five years after the 2008 collapse, yet people are still looking for an economic recovery…

“Of course there have been some bright spots, but they are isolated.  The economy remains in a weak state and won’t reach its pre-collapse level until employment goes back to its previous high, with people once again filling the quality jobs they previously held, rather than the part-time and hamburger-flipping positions that have distorted the unemployment report by making the headline number look better than it really is.

Yet the Fed continues to purchase more government debt, as its balance sheet last week reaching another new record high with total assets of $3.49 trillion.  The Fed is not tightening monetary policy, so why are interest rates rising even though the economy is weak and the Fed continues to purchase debt for its QE program?

I think there is only one logical answer, Eric:  Interest rates are rising because of QE.  We have reached a tipping point, meaning that QE can no longer keep interest rates from rising.  The market is now focusing on the dark-side of QE, which is the inflationary consequences of all this money printing.

Rising interest rates with QE ongoing means that we have reached the stage where the Fed has now lost control.  This result was inevitable because market forces always beat central planners and its groupies in the end.  Only the timing of this event could not be predicted.

Since the bailout of the financial system in the autumn of 2008, and the launch of QE in March 2009, desperate central planners had been hoping their crazy theories which try to create wealth by printing money would work.  But those theories never had a chance.  All one had to do was read monetary history to see that these schemes have always failed.

The key point is that the market is now responding to this central planning foolishness.  Capital is protecting itself by demanding higher interest rates, and as interest rates climb, the fallout will be immense.  This brings me to the second key event taking place:  Even the LBMA website now shows that gold is in backwardation.  The gold forward rate out to three months is negative.

The LBMA stopped reporting silver forwards last year because they were artificial.  They showed silver in contango, but you could not deal at those rates.  The obvious implication is that silver was actually in backwardation.  The point is that silver, and particularly gold, are not supposed to go into backwardation, at least in theory.  That’s because they have huge aboveground stocks, in contrast to other commodities that have limited aboveground stocks.

Look at the current backwardation in crude oil for example.  The August 2013 contract is $10.47 higher than August 2014.  So if you have physical crude in hand, you sell it today and immediately buy the Aug-14 contract, earning not only the $10.47 per barrel price difference but you also have the use of the $103.22 you receive as the proceeds from your sale.  To top it off, you avoid storage charges for one year.  So clearly, there is a shortage of crude oil.

Backwardations in oil can occur because its supply is limited.  Its aboveground stock is counted in days of use, in contrast to gold where the aboveground stock is essentially all of the gold mined throughout history.  So when backwardation occurs in gold, it is an earthshaking event.  People who own physical metal do not want to profit from the backwardation, even though they are only taking a credit risk for as short as one month.  They want to own physical metal, regardless of the potential profit, because earning this potential profit depends on the ability of the entity selling the future contract to deliver physical metal to you when the contract comes due.

Gold backwardation is occurring because the big bullion dealers, hedge funds and arbitragers, do not want to take this risk.  This phenomenon highlights the difference between physical metal and all of its paper substitutes.  When backwardation in the metals occurs, it means two things:  First, people want physical metal and not paper promises to deliver metal in the future.

Second, it means that the physical market is starting to drive the price of the metal, rather than what we have seen the past several months where paper selling drove gold and silver prices to abnormally low levels.  The bottom line, Eric, is that in a year or two when we look back at today, we will marvel at how cheap the prices of physical gold and physical silver plummeted to.”