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Silver Backwardation, What Everyone is Missing

Commodities / Gold and Silver 2011 Feb 17, 2011 - 03:17 AM GMT

By: Dr_Jeff_Lewis


Prudent investors make wise markets: this should be the quote above every trading desk.  The enemy of the hedged investor is not wild markets, nor bearish markets; it is their own emotions. 

With silver prices reeling to highs we haven’t seen since the 1980s, every piece of information has earned some urgency.  Immediately, the world attempts to decipher new developments and information as if there is some sort of end of the world scenario looming below.

While we subscribe to the view that the silver market is being manipulated, backwardation cannot be immediately interpreted as a symptom of such manipulation.  For that to be the case, we would have to reason that the majority of investors know about the excellent investment that is silver, as well as the market dynamics that make it so greatly undervalued.  That simply isn’t the case.

Instead, backwardation is a very clear signal, and it is not inherently a tip of the hat to a shortage in silver.  In fact, economics tells us there is shortage in everything, at least as it relates to price.  The price of silver is nearing $30 per ounce; thus, there has to be a shortage of silver at $25 per ounce, otherwise $25 would be the market price.

What Backwardation Means

The time value of money may be a theory applied best in finance and one better assigned to paper currency, but it has relevance in the metals market, as well.  When backwardation occurs, the markets are telling us that it is willing to pay less for a commodity in the future than it is right now.  Essentially, the ratio of supply to demand is greater at the long-end of the curve than it is in the short-end. 

That isn’t implicitly market moving, however.  It could very well mean what we suspect it to mean: producers are far more interested (temporarily) in locking in prices into the future than investors are buying into the future.  Consumers, those who wish to use the metal for production or consumption in manufacturing and jewelry, probably have plenty of forward contracts already…at lower purchasing prices.  Those who need silver in the future have it (assuming, of course, that there will be metal for delivery when the time comes – another issue for another time).

Bringing back the time value of money, we know that an item should be worth more in the future than it is right now.  Buying a March 2011 January future should be less expensive than a 2015 December future, since the December future should take into consideration the financing costs of borrowing money for four years.

However, what many are missing is that there is no time value of money.  Borrowing costs are plummeting, and the risk-free rate is, for all intents and purposes, null and void. 

This isn’t to say that investigation into silver backwardation and short-selling isn’t valid.  Instead, it is to say that either: A) the markets are functioning properly and the price of silver is simply reflecting the risk-free rate advantage that can be earned elsewhere in combination with miners’ willingness to lock-in prices or B) that the markets are manipulated.

Either way, it doesn’t much matter.  Money has no time value, and that isn’t natural.  Consumption is as economically advantageous as is investment.  Even if all the evidence pointing toward manipulation is found to be untrue, it is certain there is manipulation in currency, and that means silver goes higher.

By Dr. Jeff Lewis

    Dr. Jeffrey Lewis, in addition to running a busy medical practice, is the editor of and

    Copyright © 2011 Dr. Jeff Lewis- All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


17 Feb 11, 17:31

What do you mean money has no time value? That makes no sense. Of course there is a time value to borough money. What are you talking about?

Shelby Moore
17 Feb 11, 20:21
time value of $ = illusion

This is kind of difficult to explain, I guess another article I will need to write someday. But the usury is only the fiat money change relative to the value of the precious metal. Thus the so called "time value of money" is actually an illusion.

I can prove it. At the following two links is the rough outline (but it needs much work to be consolidated into a coherent explanation):

Any one who thinks it is not illusion, take a look at the logarithmic chart of the dollar over the past century:

Cheers to everyone.

I hope everyone is going to own some physical silver, I want to see all of you readers prosper in the coming fiat death spiral.

Victor Nasarbajev
28 Feb 11, 18:44
Silver backwardation

I do not agree with your interpretation of the silver backwardation.

First, there is no shortage. All the investment silver (ETFs, closed funds such as Sprott, all allocated silver in the vaults, and your silver coins at home) may be for sale, depending on the price. If there is high demand, the price can go up until people sell their silver. What matters is not whether the price might have to increase, but whether the silver is there. It is there indeed. And it will be for sale at some(!) price.

The futures price for silver (COMEX) or the forward price (LBMA) has two components:

* the spot price depends on supply and demand

* the term structure (contango or backwardation) is enforced by arbitrage and depends on the interest rate difference.

Since there is no shortage, there is no reason to think that term structure arbitrage would have stopped. If it has not stopped, backwardation tells us something about the interest rate difference between silver and the US$. It tells us is that there is significant counterparty risk in the silver swap market, namely that the borrowed silver might not be returned.

If you'd like to see the arbitrage argument written out in detail, please see

So what backwardation says is that the market does not trust the counterparties in the common silver swaps. This trust was apparently suddenly lost on January 19, 2011, at the bullion banks that form the LBMA. On that day, the SIFO (Silver Forward Offered Rate) turned sharply negative. It has not become positive again ever since then.



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