By Gijsbert Groenewegen
What is the significance of backwardation in a down market?
We are witnessing backwardation (spot price higher than future price) in a down market, which is unusual! Why? Because backwardation normally only occurs when prices are rising and there is such strong demand and such limited supply that the prices for spot are higher than the future prices, which include interest and storage costs.
Backwardation especially happens just before the harvest of agricultural (consumable) commodities when there is a lot of demand and no supply yet and when a situation of scarcity exists. The situation is different for precious metals because there is no scarcity of above ground gold and silver inventories.
The main reason for backwardation in the case of precious metals is that the supply is extremely scarce because holders of gold and silver don’t want to dispose of their physical gold and silver, not because there isn’t enough gold or silver, but because the gold and silver investors don’t know if they will be able to get the physical back in the future if they sell it spot, now.