March Silver in Backwardation

Keith Weiner

|

January 6, 2012 - 7:02am

March silver has been flirting with backwardation since the end of 2011, and today it has moved more firmly into backwardated territory. This is extremely bullish for silver, and let me explain why.

Backwardation means (and I am oversimplifying a bit here) that a futures contract is cheaper than buying the physical good in the cash market. To understand the meaning of this, the first question is this. Is it possible to warehouse the good? If not, then the futures market is simply the market's opinion of what the price is likely to be on the contract expiration. I am not going to discuss this case any further, as it is not that interesting and it is not germane to silver.

Silver, unlike interest rate futures for example, can be warehoused. This means it is possible to simultaneously buy physical silver in the spot market and sell a future in the futures market. One has no net exposure to the *price*. One is exposed only to the *spread*. This is a simple arbitrage. One can "carry" a good (buy spot, sell future).