Silver Backwardation Or Corzine-ation?

This story is interesting. The silver market has severe backwardation. The PSLV silver fund is trading at a 30% premium to net asset value (NAV)! The PSLV fund claims that it has 100% of its holdings in a vault in Canada. Under certain circumstances, fund shareholders may redeem their shares for actual silver, including individual non-institutional shareholders!

GLD and SLV are ETFs. Institutional traders may create or redeems shares, but not individuals. That guarantees that the share price will stay close to the NAV. However, GLD and SLV may lend their metal to short-sellers, or invest in paper equivalents. Allegedly, the bank that manages the GLD and SLV fund is also a massive short-seller of gold and silver! If you read the fine print in the fund prospectus, shareholders get stuck with any losses due to fraud or incompetence. Sometime in the next 5-15 years, there will be a default on one of the big PM funds, and most investors will switch to physical metal.

PHYS and PSLV are closed-end funds. They can never trade at a discount to NAV, because then investors would redeem shares. However, if the shares start trading at a premium to NAV, the fund manager can buy more metal and issue more shares. The fund manager of PHYS and PSLV claims to have the shares 100% backed by metal, stored in a warehouse in Canada. Are they having a hard time obtaining physical silver, leading to big premiums and a large NAV discrepancy? Why would a rational investor pay a 30% premium for a paper silver fund?

This 30% premium is a symptom of silver backwardation. The gold and silver futures markets also are in backwardation.

I don’t see any reason to trust the PSLV fund manager more than any other fund manager. When one PM fund defaults, they probably all will. I wouldn’t pay a 30% premium for PSLV. Plus, the PSLV vault is in Canada, which could be a problem for someone living in the USA who wants to take delivery of their silver.

“Backwardation” means that the short-dated futures are more expensive than longer-dated futures, an apparent contradiction. The normal state is “contango”, where longer-dated futures are more expensive than shorter-dated futures. This higher prices reflect cost of capital and cost of storage, which you save by buying a longer-dated future compared to a shorter one.

Do you understand why, if traders are rational, gold and silver futures should *ALWAYS* be in backwardation, from now until the State financial system completely collapses?

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Here’s the argument for why gold and silver futures should never enter backwardation, *IF* people trust the financial system. If you own a gold bar and gold futures are in backwardation, then you can make a guaranteed riskless profit *PROVIDED THE FUTURES MARKET DOES NOT DEFAULT* and *PROVIDED THERE IS A SAFE BOND INVESTMENT*. You sell the gold bar, buy a future, and invest the money in government bonds. When the future expires, you pay for the future and get your gold bar back. Your profit is the amount of backwardation plus interest on the bonds. Currently, interests rates are 0%, so you just look at the futures prices. You could hold the cash rather than buy a Treasury bond for 0% interest. Technically, you should subtract interest rates from the futures prices when performing the backwardation calculation.

After Corzine robbed his customers, the futures markets are no longer risk-free. The “PROVIDED THE FUTURES MARKET DOES NOT DEFAULT” clause in the above calculation no longer holds. The amount of backwardation should equal the risk that people will get Corzined again.

“Gold and silver should never have backwardation!” assumes a zero default risk. Now that there’s a clearcut default risk, there should always be backwardation. Shorter futures contracts are less exposed to default risk than longer contracts. Therefore, shorter contracts are more valuable.

How big is the default risk? MF Global represented 40% of all futures contracts, at the time of bankruptcy. To stick with round numbers,customers lost 40% of the value of the account. Therefore, the “default risk” in 2011 was that futures market customers collectively lost 16% of their investment. That translates to a default risk of 1%-2%+ per year going forward, assuming that things are getting worse.

What is the actual customer loss rate? This link had some interesting bits. A pro-State troll says “The way to calculate customer loss is ‘Cash eventually repaid to victims divided by account balance on bankruptcy date.’” That is false. There’s the cost while your capital is tied up in bankruptcy court. There’s the cost of having your account frozen. There’s the cost of margin calls until the bankruptcy claim is paid out.

The bankruptcy trustee claims to have repaid 72% of claims. On person, Paul Hamann, claims to have only been repaid 3%. If you add all the factors, my loss estimate of 40% seems reasonable.

There’s another neat loophole.  The deadline for filing a bankruptcy claim is the end of January.  If you don’t file a claim, you may waive your claim!  Corzine’s victims will probably have to hire a lawyer, to make sure they recover their money and that their bankruptcy claim is filed properly.

The MF Global bankruptcy represents a new low point for bankster corruption. For the first time ever, customers on a futures exchange lost money due to bankruptcy/fraud/theft/default. A CME executive will argue that it technically wasn’t a clearing default, but that makes no difference to customers who lost money. A precedent was set. Even if the law is changed and clarified, another loophole will be used next time. Nothing prevents a crooked CEO from stealing customer money and lying about it.

This is a symptom of increasing bankster corruption. If the MF Global bankruptcy occurred in the 1950′s, the CEOs of the big banks would have gotten together and said “We don’t want customers to lose faith in the financial system. Let’s find some money to repay the customers.” There would have been some deals, maybe a secret loan from the Federal Reserve, and the customers would have immediately been made whole, even before the bankruptcy filing. The customers would have lost nothing.

The CME has a market capitalization of $15B. Now, the CME and COMEX are proven to be one big fraud. The fair market value of the CME is now obviously zero. Only idiots are still using State futures exchanges. Wouldn’t it have been worth $1.2B to preserve the illusion of integrity in the futures markets? The banksters got too greedy.  One of the bankster golden gooses, the futures markets, is now dead.

Also in the 1950′s, the bankruptcy judge and bankruptcy trustee would have aggressively clawed back any pre-bankruptcy payments by MF Global. Allegedly, the bankruptcy trustee is going easy on the other banks, because he worked for them in the past and expects to work for them again in the future. The judge said that the bankruptcy trustee is impartial, even though the trustee worked for JP Morgan in the past and JP Morgan is at risk for clawback. The fact that the judge felt obligated to say that shows an obvious conflict of interest.  Who is the bankruptcy trustee really advocating for, pathetic losers dumb enough to buy futures, or banksters who will reward him with a lucrative consulting contract if he does a “good job” managing the bankruptcy?

Also in the 1950′s, there would have been criminal prosecutions by now. In China, they execute corrupt CEOs, although only small fry usually get caught. China is a more civilized country than the USA.

A retail customer on a futures market has a default risk of 1%-2% or more. This default risk should be factored into futures prices. Therefore, futures contracts should always be in backwardation, because shorter futures have less default risk exposure.

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