Every time gold briefly slips into backwardation, some gold commentators are quick to write that this was abnormal and, in theory, should not be possible. In the following, I give several reasons why, in my opinion, the opposite is true: Not contango, but backwardation in gold should be the norm. If this is the case, then the fact that gold has been in contango for essentially all of the last 25 years strongly suggests central bank interference with the gold market.
In London, when quoted between banks, the Dollar’s interest rate is called LIBOR. Gold’s interest rate, however, is usually called the “Gold Lease Rate”. It measures how many Dollars someone gets for leasing a certain amount of gold to someone else for a certain amount of time. For instance, the Gold Lease Rate is determined on a daily basis in the London Bullion Market and quoted for maturities of 1, 2, 3, 6 and 12 months. Every now and then, but rather seldom, LIBOR for some maturities falls below the corresponding Gold Lease Rates. Borrowing Dollars is then cheaper than borrowing gold. This also means that the forward price of gold (e.g. in 1 months time) is lower than today’s spot price. In futures markets, this is called “backwardation” – in contrast to the state of “contango”, in which the future price would be at a premium to spot. Before this most recent stretch, backwardation in some gold maturities had, for instance, very briefly happened in the London Bullion Market in 1999, 2001, and 2008. Every time gold shows this behavior, an old myth rears its ugly head, namely, that in theory this should not be possible.
Thanks to BrotherJohnF