Silver in Backwardation - again!

Futures Silver prices are in backwardation again. Take a look at the snapshot below:

Note the column labelled "Last". The prices that are further into the future are lower than the cash price or the September '12 price. This is rare and abnormal in the silver market and is usually an indication of physical shortage or suspicion of shortages. There has been much previous speculation that silver shortages would become more acute. This BBC article from mid-April, 2012 is an example. The recent rebound in the price of silver is consistent with these observations.

Eurobonds - does Gold have a role?

A politician up a tree is a very resourceful creature. Ditto for central bankers! So in this vein, yet another proposal is being trial-ballooned with the aim of saving Euroland from its debt mess while off-loading some of the responsibility from Germany who so far has stridently resisted becoming its one and only financial backstop. The idea is to attract bond purchases and at low rates (similar to Germany's but without Germany becoming the guarantor) by getting European nations to pledge their gold as collateral for these bond issues. It must have been difficult for some of these bankers, finance ministers and heads of state to admit a possible role for that "barbarous" relic, gold.
The problem is that, at current prices, the Euro nations' gold stash is worth "only" about $2.3 Trillion. That just happens to be about the size of Italy's debt alone! So, It might look like a heady sum at first but let's take a look at what the gold price would need to be to back the debt of some of the countries at the centre of the debt fiasco using each nation's stated gold reserves. I've added a few others in for comparison as well. Source data is from the World Gold Council, the World Bank and Eurostat.

From the chart it is readily apparent that gold prices would need to be between $20,000 and $100,000 per ounce to back the debt of any of these countries. Of course, some of the proposals to date suggest backing only some of each nation's debt (maybe half, say). But on the other hand, some of the gold in the reserves is likely already pledged or leased and therefore "encumbered". Nevertheless, the true scale of the problem becomes evident when even the United States with its supposedly unencumbered gargantuan holdings of  8,133 metric tons of gold would need a $60,000 price per ounce to cover its $15 Trillion debt.

J.P. Morgan and the Zero Sum Game

It's interesting to observe the performance of the Fed's and Wall Street's favorite sons. They have all the connections and insider info that most of us could only dream of and they routinely make lots of money, quarter by quarter. But are they really so smart?
If money supply and growth were constant, investing should be a zero-sum game. That is, if someone is making money, someone has to be losing money. But in these times of rampant money creation, it is possible for most of us to win most of the time, at least in nominal inflated dollars. The part that I find interesting is that every time the money creation machine slows down a bit (we are awaiting QE3/4, no?) and markets waver a bit, folks like Jamie Dimon often start tripping over their shoelaces, even though the odds are seemingly so stacked in their favor. It happened with Lehman and AIG a few years ago. Maybe Morgan won't go that way. But I can't help thinking that these mega-remunerated CEO's could not run a real business in the real world without being back-stopped by bailouts when things go wrong, without counting on huge money creation off which they can skim almost risk-less profits and without their priveleged connections and information sources. After all, who runs the Federal Reserve?
Yes, in spite of the supposed odds, they still manage to make mistakes, really big ones, sometimes. Sometimes big enough to bankrupt the company. How long can the world's central banks accelerate their printing and backstopping operations to keep these guys and our supposed economy afloat? Methinks that the zero-sum game will return with a vengeance one of these days.

How well are foreign holders of US$ debt doing?

Folks have fretted over the possibility of a huge U.S. bond bubble for a long time. In particular, some have warned that China, in particular, might suddenly begin dumping large amounts of accumulated Treasuries. In fact, China has been dumping US Treasuries and the Federal Reserve has been forced to compensate by printing up the difference (quantitative easing) to a good degree. See here. But so far this exit from the US$ has been controlled. Partly this may be because other major currencies are also having trouble so that the US$ is seen as the best of the worst. Since the 2008 crisis, Central Banks around the world have been pumping - buying their own debt - see here. So, while the US debt infrastructure may slowly be crumbling, a fast look at the recent performance of US$ denominated long-term debt (30 year Treasuries) from the perspective of foreign holders shows that for the time being everything looks pretty good.

The above chart depicts the performance of 30-Year US Treasury Bonds in terms of the US$ index. Typical foreign holders make money in their own currencies if 1) the US$ rises and 2) the Bonds themselves rise. By charting the US$ index divided by the bond yield, we get an approximation of the combined effects of bond price and US$ price relative to other currencies.

Thus, while many participants may be nervously glancing at the EXIT doors to spot an incipient mass exodus which would precipitate an implosion of the so-called bubble, those exiting now are actually doing very well from an investment perspective. Anyway, the current focus is still on Europe - Greece, Portugal, Italy, etc. But markets will eventually turn to the biggest debtor of them all - the U.S.

Backing the U.S. Dollar with Gold

There has been a lot of speculation regarding the resurrection of the gold standard to address a possible crisis of confidence in the U.S. dollar should markets begin to focus on increasing U.S. indebtedness and growing fiscal imbalances. Potentially, this elephant in the room is a lot bigger than the European debt situation. This speculation is partly driven by the very large purported U.S. gold reserves of 8133 metric tonnes or approximately 262 million troy ounces which comprises by far the largest gold holdings of any nation. Could this gold hoard rescue the U.S. from a potential financial catastrophe down the road? Maybe, but only if gold were revalued much, much higher. Some observers suggest that monetary aggregates such as M1, M2 or M3 should be used to determine the price to which gold would need to rise for markets to accept a gold-backed dollar if a crisis of confidence were to occur.  I decided to use figures for the U.S. National Debt instead. More importantly, I wanted to see how the debt of the U.S. compared to its gold reserves historically.

Between 1900 and 1940, U.S. indebtedness was typically two to ten times the gold price. Between 1940 and 1970 U.S. debt rose sharply and this ratio ballooned to almost 30. That's when the big catch-up in gold prices occurred and by 1980 the ratio was brought back down to 5 or so. After this the ratio zoomed again up to 65 or so by 2001-2002 at which point Gold entered another catch-up phase which continues to this day with the ratio at about 37 in early 2012. If we assume that the ratio will reach 5 again, gold would need to be $12,000 today.

But . . . U.S. debt continues to rise and some have speculated that not all the gold in Fort Knox and elsewhere is there anymore! H'm m m.