Ever since early fall 2010,
long-dated silver futures have been in backwardation. This means the price of
a silver future for, say, Dec 2015, was *lower* than the price of silver in
the spot market. One could have earned a "risk free" profit by
simultaneously selling physical silver and buying a future. When the future
delivered, one would have the same silver holding. The trade would require no
credit, only that one have silver (which many people and banks do). And yet
for nearly a year and a half, the backwardation persisted. This is because it
was *not* risk free. There is one risk: default. What if the future did not
settle in metal, but in paper?
The backwardation has been
subsiding for a long time. A year ago, silver was backwardated for contracts
in 2013. Last summer, it was only contracts in 2014. Recently, it has been
only 2015. Yesterday, around 9:30 am PST, the backwardation disappeared
altogether. And this new market condition appears to be holding.
The enclosed graph is a
snapshot. At one instant in time earlier this morning, I grabbed the basis
and cobasis for each future contract in silver out to Dec 2016. Recall the
basis is the profit one could make by buying physical and simultaneously
selling a future. The basis, represented by the blue line, is positive
through 2013. The cobasis, represented by the red line, is the profit one
could make by the arbitrage I suggested above: sell physical and buy a future.
The cobasis is now not
positive, i.e. there is no profit, for any contract out to Dec 2016. This is
not bullish for the price of silver.
But I want to touch on
something else. Since December, and especially in the past several days,
liquidity spigots have been turned on full. Yesterday, everything from copper
to equities to the euro to silver rallied relentlessly. From the change in
the silver term structure, it's obvious that there was some significant
selling of physical / buying of futures. This is the *only* action in the
market that could eliminate a backwardation.
The flood of liquidity
provided a cover for selling of physical metal, and prices actually rose
during this process. Now the banks have corrected their duration mismatch in
silver lending (or whatever was the root cause of this persistent
backwardation). Once this process plays out, then the marginal buyer of
futures leaves the market. If the new non-backwardated state holds, the price
of silver could fall hard.
The irony of this is that the
conspiracy theorists of the world will attribute the price fall to naked
short selling of futures! As soon as the bout of liquidity ends, watch out
below. And watch for the conspiracy theorists!
