As discussed in our recent article (Gold Backwardation and Negative GOFO – What does it all mean?) these 2 terms, GOFO and backwardation, were hardly mentioned just 6 months ago but are now popping up all over the place. There has been plenty of debate, not just as to how significant or otherwise this is, but even on what the definition of backwardation actually is.
It was via Sandeep Jaitly, along with Professor Antal Fekete, that we first came across the concept of backwardation in the gold market. (If you are yet to read about backwardation then we’d recommend you read this recent article of ours first).
This week we came across a great interview with Sandeep on tfmetalsreport.com where he covers backwardation and GOFO.
The interview covers:
- Backwardation in general and how this relates to the current negative GOFO rates.
- The ongoing breakdown in the price relationship between physical and paper metal.
- Since the LBMA no longer publishes SIFO, can we draw any conclusions regarding silver?
It’s only 25 mins long and you can visit the link above to listen although the podcast player wasn’t working for us when we tried. Or the link to the podcast is below).
Download podcast (Right click and choose “Download as”)
However we have summarised the content below also if you prefer to read…
Sandeep Jaitly on Backwardation
Sandeep begins by discussing how the December futures contract on the Comex just went into backwardation and how it’s the earliest that the December contract has ever gone into backwardation.
The OTC (Over The Counter) measure of the Gold forward rate went negative a month ago – completely unprecedented – as it has never been negative for this long.
They then discussed (as we do in our above mentioned article) the fact that many other analysts have commented that the whole curve has to be in backwardation to be “proper backwardation”. That is they believe that just having the spot price higher than the nearest contract is not “proper backwardation”.
However Sandeep explains that gold and silver have virtually constant marginal utility – not like oil or wheat or other commodities. (simple definition of marginal utility would be once you’ve got somehow much more you would like to have the next unit of whatever it is you’re talking about).
And how if you look at the percentage of open interest in the first 3 contracts is always between 80% and 90%. We never see more than 10% of outstanding open interest in far dated contract.
This shows that people involved in gold futures are only interested in “playing” with the first 3 contracts – more than 2/3 of open interest are actually in the first 2 months! So the significance of further dated contracts is actually pretty low.
Sandeep was then asked about the negative GOFO rate on the London OTC market.
With regard to this there can be only 2 options as to why it has occurred:
1. Someone is in trouble or
2. Miners are hedging
He contacted a number of miners and analysts and reported that very few if any are hedging – that is they are not borrowing physical gold or silver. So the negative GOFO rates can not be due to this.
So rather someone is in trouble. That is, someone has written gold obligations and now has to settle them.
However Sandeep did explain that it is not necessarily a case of “gold not being there”. It might instead be a case where gold is lent out for a very long period – say 5 years until they get it back. If they are seeing obligations come through at a rate that would cause them to panic, they would then borrow bullion for a shorter time frame therefore bidding up the lease rate to offset their 5 year obligation.
So we are seeing an “unwillingness of holding a gold obligation in dollars – they want the gold”.
Sandeep was then asked “So unless we get some overnight event like a gold backed currency what is it we moving towards in slow motion?”
It’s too early to say when the futures market will default. You’ve seen gold draining from Comex but silver arriving into Comex. He thinks it’s likely gold from outside the Comex system will come into the Comex system – they are getting it out of the woodwork as much as they can to settle these obligations. So a default is most likely not imminent.
Finally ‘What will the world look like if there is no gold futures market?”
He hasn’t figured it out yet! Consider India’s retail gold market – gold is priced by the gold fix in the futures market. So if there is no futures market and therefore no gold fix, will Indian jewellers not offer gold for Rupees?
If this happened then the Rupee could lose a lot more value than the dollar at that point. Therefore he thinks the dollar is the last currency to die because of this reason. We’ve heard Sandeep say this before, but we can’t think of anyone else we’ve heard it from. As he mentions most other analysts just talk about the collapse of the dollar.
Final question was “If the LBMA was still printing a SIFO (Silver Forward Rate) rate would it be negative like the gold forward rate?”
Sandeep said September silver is in backwardation to the tune of about 1% to 1.25% annualised and only a couple of weeks until December silver moves into backwardation. So yes SIFO woudl likely be negative too.
His parting comment:
“It’s going to be very exciting over the next month or so!”