Friday, February 18, 2011

Gold and Silver Backwardation

In normal futures markets the spot or cash price is less than the price for delivery of the goods at some distant time. This normal condition is called “contango” in futures terminology. In contango the price of further out futures contracts is higher than nearby or closer in time contracts. For example, the price of a contract for delivery of goods in April is more than a contract for delivery in March and so on. This condition reflects the carrying costs of warehousing and maintaining the goods until delivery in the future.

The opposite condition, where the spot price is higher than the price of future delivery contracts is called “backwardation.” Backwardation occurs when buyers are willing to pay a higher price to have the goods now. Backwardation is a sign that buyers anticipate shortages of the goods in the future due to immediate demand.

Backwardation in gold and silver is very rare. Silver is now in complete backwardation or “zero contango.” This condition exists out till 2015. That is, the silver price of every contract month is lower than the next further out month. Backwardation is bullish for silver price and indicates demand by retail investors and industrial users is strong. The Silver price leads the gold price in a bull market. Will gold also go into backwardation? If so, that would be extremely bullish for the gold price.

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