Talk to the precious metal bugs, and you’ll soon come across the story that there is a growing disconnect between what’s happening in the futures market and the physical market.
This, they say, is particularly the case for silver, where rumours of retail shortages have been doing the rounds since about the start of the year.
On top of that, the silver forward market, as assessed by the London Bullion Market Association, did something relatively unusual last week. It flipped into backwardation — a situation which sees the price for physical silver today (spot) become more expensive than that for delivery in the future.
This is reflected in a negative silver forward rate. On Tuesday, for example, the three-month rate was still sitting stubbornly negative at minus 0.09750 per cent, having gone as negative as minus 0.17000 per cent on January 20.
Now, due to the financial characteristics of gold and silver — albeit less so in silver’s case due to greater industrial use — this backwardation structure is not the norm. Prices usually ascend into the future to compensate cash buyers for the missed opportunity of collecting an overnight interest rate, less the cost of storage which is borne by the holders of the physical metal.
While backwardation in the LBMA rate is not unprecedented, the scale and severity of the recent flip has been, say market participants .
The last time the three-month rate fell as dramatically was in October 2008, and even then it only turned negative (went into backwardation) in January, remaining so until March 2009:
A tale of two silver markets.
But here’s the thing. While, backwardation normally suggests market tightness, in reality there have been some conflicting messages coming from the market in terms of supply and demand.
On one hand, supporting the case for tightness, data from the US mint last week showed that sales of American Eagle silver coins hit a monthly record of 4.6m coins in January, surpassing the record struck in November last year — even before the month was over.
Traders also point to the unusual situation of a premium having developed in the price of North American silver versus that traded in London.
On the other hand, according to Suki Cooper, precious metals analyst at Barclays Capital, the broader supply and demand picture currently looks healthy.
What’s more, the fall in silver price since the beginning of the year has been convincingly matched by robust outflows from silver exchange traded products (ETPs) — denoting lower demand from the investment universe.
As Cooper told FT Alphaville:
Backwardated markets tend to reflect current supply tightness or a sharp increase in the near term demand with low inventories. But, at the moment silver is finding conflicting interest in terms of investment demand.
The outflows out of iShares’ Silver Trust, for example, have only very recently abated, noted in the Trust’s shares outstanding:
But then again, could it be that it is ETP redemptions — encouraged by falling prices — that are contributing to high demand for physical spot silver delivery to ETP authorised participants?
Either way, the plot thickens.
Related links:
The gold backwardation theory – FT Alphaville
Getting to the bottom of negative gold-leasing rates - FT Alphaville
Does Carlos Slim really ❤ silver? – FT Alphaville
JPMorgan cuts back on US silver futures – FT Alphaville