"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat

Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput


Friday, February 25, 2011

Backwardation Structure appears to Easing in Silver - but is it?

The strong backwardation structure that has existed in the silver market for some time, at least on the futures board,  appears to be easing even as the March contract goes into its delivery period. This is happening even as we continue getting reliable reports of tightness in the spot market and long waiting periods for silver bars.

March silver's open interest is drawing down rapidly having dropped a bit over 14,000 contracts in yesterday's wild session. There is a decent amount of rolling out of March into May based on the exchange's today, but it is not a one for one roll. Both longs and shorts bailed out yesterday.

There are still a considerable number of contracts open in March, 14,259 to be exact, but we have today's session yet which no doubt will see a further reduction in that contract month.

If a squeeze is going to occur, we will need to see the March return to a premium to the May and preferably also to the July.

Here are the spread charts detailing the change from one of backwardation to a more normal contango situation. When a backwardation structure exists, the spread line will be above zero; when contango exists, the spread will be below zero.

As you can see, the backwardation structure has been easing. At the risk of repeating, if there will be a move to push the shorts during the delivery period in the March next week, this spread line will indicate it by moving back above zero against the May and if it is particularly strong, also against the July contract. I do wish to point out however that while the backwardation structure of the March has eased it is just barely in contango.

Keep in mind that this chart is a snapshot in time and can change so we will need to continue to monitor this for further developments.

To get an even more accurate read on this we would need to capture a snapshot in time comparing the spot silver market bid/offer to the current bid/offer of the nearby March silver contract. At the time I am posting this, spot silver is actually trading about 6 - 7 cents higher than the nearby March futures contract which makes the current structure of the Comex silver market seemingly at odds with the physical market once again. In other words, we have a rather strong backwardation in the physical market but an easing backwardation moving towards contango on the paper market.

An ideal situation for a short squeeze exists when both the futures board and the spot market are speaking with the same voice. In the case of what we have now, if the physical market is as tight as it seems to be, there should be a large number of players standing for delivery in the March. AFter all, if you are a large buyer of silver, and you can get the exact thing by buying a March futures contract at what is a DISCOUNT to the physical market, who in their right mind would not want to do that? If nothing else, a player with the right connections could arbitrage the setup and guarantee an immediate and healthy profit.

Stay tuned on this one. With Silver there is never a dull moment.


  1. Dan,

    Looking at the trading volume today I noticed there was more volume on the next delivery month of May than either April or March. This makes me wonder if traders are already picking up the next delivery month and if so should we now start with the May contract when looking for backwardation?


  2. Dan,

    when you calculate the contango, why do you look only at the first one or two months (March 2011 minus spot)?

    This might be distorted when the crowd rolls from March into May.

    If you plot the entire term structure from (physical) spot up to Dec 2015, you should see the "intrinsic interest rate" of physical silver versus US$, just as with a pair of currencies. The Dec 2015 is still more than 1 US$ cheaper than Mar 2011.

    A good picture was on Zero Hedge:


    If I take the currency point of view seriously, then what are the interest rates?
    US$: yield plus risk premium minus storage (storage is zero)
    silver: yield plus risk premium minus storage (yield is zero, storage is small positive)

    As silver is in backwardation, the interest rate of silver is greater than that of US$. Or, if you swap your physical for USD, you receive(!) interest. Normally (in contango), you would pay interest.

    For silver, the yield is zero, and storage is small positive, and so the risk premium for silver on the commodities echange is positive! This can only mean perceived counterparty risk.

    btw: I do not buy the story that the backwardation accurs because the is no physical silver available. That is BS. There is a lot of physical sitting in the ETFs, private vaults or at home in the basement of the average Joe. There is some price in US$ at which this silver will become liquid. This is the reason why you need to interpret the backwardation as a currency pair silver/US$.


  3. victorthecleaner:

    The reason for the look at only the first three months on the board is to attempt to discern whether or not there is going to be an immediate run on the Comex due to a strong short squeeze during the delivery period.

    As such the board structure for the first few months is the only one I am immediately interested in.

    this is not to dismiss your points about the entirety of the board structure way on out. What this structure is currently telling us is that for the immediate term, there is a shortage of willing sellers at current price but down the road, the board is telling us this will ease as more supply becomes available.

    Please bear in mind that I am speaking directly to the short squeeze potential during the delivery period as I believe I made very clear in the post.

    Thanks for commenting.


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