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COMPETING
PARADIGMS
During
an interview with Contrary Investors Cafe on 24
February 2009 I discussed both gold
backwardation and silver backwardation. After the interview I was
asked why more commentators are not discussing this issue. I do not
know.
Regarding
money there are two competing views: (1) money is determined by the
market or (2) chartalism
which asserts that ‘money is a creature of
law.’ Governments can only manage money if they create
it. Obviously, the market determines money because money existed before
governments were created.
Regarding
gold there are two competing paradigms: (1) gold is a commodity and (2)
gold is money. Paradigm (1) asserts that gold is a hedge against
inflation and there is no monetary demand for gold. On the other hand,
paradigm (2) asserts that gold is a hedge against currency collapse and the
primary demand for gold is monetary. I subscribe to the second paradigm
and assert that at all times and in all circumstances gold remains money.
WHAT
IS SILVER’S ROLE
Under
which paradigm does silver fall? Is silver a commodity or is silver
money? For a commodity to be money its primary demand must be monetary.
Like
gold for thousands of years silver functioned as money in the market.
The term dollar, as used in Article 1 Section 9 Clause 1 and the
Seventh Amendment of the US Constitution, is defined as 371.25 grains of fine
silver under Section 9 of the Coinage
Act of 1792. Governments stockpiled billions and billions of
ounces. However, on 24 June 1968 the United States government defaulted
on their silver certificates. Over the decades silver, like gold, has
been demonetized in ordinary daily transactions. Supposedly
there are large stockpiles of gold in central bank vaults. Unlike gold
there are no reported large above ground stockpiles of silver stashed in
central bank vaults. Additionally, a large portion of silver demand is
industrial as it is used in cell phones, refrigerators, dental equipment,
computers, etc.
Therefore,
it appears that silver
is confused about its role. In other words, silver
functions as a commodity and as quasi-money.
FIVE
WEEKS OF SILVER BACKWARDATION
While
similar there are differences between future and forward contracts. For
example, future contracts are traded on exchanges, use margin and are marked
to market daily. In contrast, forward contracts are generally traded
over-the-counter (OTC derivatives) and are not marked to market.
Therefore, forward contracts are subject to greater
counter-party risk than future contracts.
Because
the primary reason backwardation arises is counter-party risk and because
forward contracts are impregnated with greater counter-party risk
than future contracts therefore it is highly likely that backwardation would
appear in the forwards markets before the futures markets.
This
is precisely what has happened. While the COMEX silver
futures contract have not been in backwardation the LBMA Silver Forward Mid Rates have been in backwardation for five consecutive
weeks. Of particular interest is the 6 month contract.
SO
WHAT?
What
does all this mean? Well, I think the backwardation reflects the market’s
uncertainty of silver’s role as money. The
chronic silver backwardation began on 8 December 2008, the same day I wrote
about gold in backwardation, and silver was priced about $9.60.
Currently silver is trading about $13.82. Predictably, the
gold/silver ratio is narrowing. If the backwardation persists it will
be interesting to see if silver’s price in illusory FRN$ continues
rising.
In my
opinion, as the great credit contraction grinds on and intensifies the
commodity silver will reassert itself as money and eventually currency.
As I mentioned during the interview with Contrary Investors Cafe what would be
really interesting is if the central banks decide to start hoarding silver!
In the
meantime it may behoove those who are bullish towards silver to increase the
pressure on physical silver delivery. For example, I purchased some
beautiful Austrian philharmonics at the Cambridge House Investment Conference
and Silver Summit over the weekend. The beautiful coin cost $20 which
was an amazing $5.50 over spot.
While
there are cheaper ways to purchase physical silver bullion, like GoldMoney,
these huge premiums over spot beg the question: What is the real silver price?
With the specter of counter-party risk driving silver into
backwardation if
there is a failure to deliver then it will likely cause the silver price to
shift from the COMEX just like a failure to deliver would cause the
gold price to shift from the COMEX.
Bottom
line: Do not get caught with your paradigms down!
Trace Mayer
RuntoGold.com
Trace Mayer,
J.D., holds a degree in Accounting from Brigham Young University, a law
degree from California Western School of Law and studies the Austrian school
of economics. He works as an entrepreneur, investor, journalist and monetary
scientist. He is a strong advocate of the freedom of speech, a member of the
Society of Professional Journalists and the San Diego County Bar Association.
He has appeared on ABC, NBC, BNN, many radio shows and presented at many
investment conferences throughout the world.
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