Gold Backwardation?

Typically gold will only go into backwardation when either there is fear of a currency collapse and/or doubt as to whether counter parties will be able to produce gold as promised. Obviously under a currency collapse scenario, the latter typically accompanies the former.

With gold currently rallying in all fiat currencies (it hit another new high in pounds just yesterday as you can see in the chart below), I suspect gold’s current backwardation says more about the intense physical demand we’re seeing. Also, the doubt as to whether counterparties can actually make good on promises of gold (see the potential for a squeeze in the Dec contract here and note that “first notice” is this Friday for those that may take delivery) as well as a general loss of confidence in the fiat dollar-based global monetary system. All this rather than just fears about the value of the dollar itself vs. other fiat confetti.

click to enlarge: http://tinyurl.com/6yejjw

I think there’s a good chance that gold can rally fairly quickly to the $1200 area over the next month or two as the dollar gives up much of its gains since July vs. the other major currencies, although gold would obviously be rallying in all of these currencies during that period, just as it is now. And the metal could perhaps rally even further should there be an “event”, such as the PBOC increasing its gold reserves by 4000 tonnes (over 6 times the gold that the GLD ETF holds) as the PBOC has “floated” several times in various Chinese newspapers, such as The Standard, over the past several weeks

Longer term, I think we’ll see the Dow/Gold ratio fall into the low single digit area (just as we have after every secular bear market in equities since 1900) and perhaps even to 1 to 1 as we saw in 1980. Where that number is depends on how much the Fed inflates and how much we see in outright price declines in asset prices. My “guess” is somewhere aorund $4000 to $5000 an ounce, which might be where the dollar is eventually re-tied to the gold price, but again, that’s just a guess.

And that guess may well be too low given the Fed’s current inflationary path. Consider that if the Fed were to try and tie its liabilities (which have been rising by about $200 bln a week of late and will probably hit $3 trillion by year-end according the Fed’s Fisher) to the US gold reserves of 8133.5 tonnes on a 1 to 1 basis, it would require a gold price of over $8000 an ounce.

- Lance

All roads lead to Rome.

RUF