Basis and the Negative Thereof
Dr. Fekete uses
Basis = (NearFuture(time) - Spot) in $/troy ounce
rather than the more common
Basis = (Spot – NearFuture(time)).
This does not affect people's use of the terms contango, backwardation, and the rest.
And it permits us to say that basis is the carrying charge, rather than having to say that carrying charge is the negative of the basis.
But terms such as rising, falling, positive, negative, increase, decrease, and others have the potential for confusion!
I have the very greatest
respect for Antal Fekete and I owe him much in my quest to understand
money and protect my savings.
So imagine my disappointment as in late 2008 I found apparently-conclusive evidence that there is something confusing in most of his excellent expositions of gold basis!!! While I'm certain Dr. Fekete is not confused about the below, I think many if not most of his readers are!
I think Dr. Fekete's several expositions of basis are essential to understanding money and I am greatly saddened by the awareness that my long-standing confusion has probably been shared with most of his readers, particularly those with training in mathematics and also having experience with commodities.
Professor Fekete's resume describes extensive mathematical knowledge, and clearly he himself is not confused. The problem is definitional:
Dr. Fekete consistently uses Basis = (NearFuture - Spot)
Nearly everybody else uses Basis = (Spot - NearFuture)
The below will add detail.
I am asking for clarification, and any I get will be used to revise/correct this web page.
Frederick N. Chase email@example.com
Dr. Fekete offers us insight into the
basis of a commodity
, often in the context of the warehouseman.
From a general search (http://www.google.com/search?q=define%3A+basis ) we see that
clearly the general use for basis in the context of commodities and the English-speaking world is (Spot minus Futures) as opposed to (Futures minus Spot).
For example, for the (Spot minus Futures) definition of basis see any of these:
Understanding Basis, by the Chicago Board of Trade p25 -- “the difference between the local cash price of a commodity and the price of a related futures contract; i.e., cash price - futures price = basis”
Understanding Basis, by the Chicago Board of Trade p2 “Local cash price – futures price = basis”
A User's Guide to Understanding Basis and Basis Behavior in Multiple Component Federal Order Milk Markets “Basis = Spot price of asset to be hedged – Futures price of contract used.”
The only use of the minority (Futures minus Spot) definition of basis I've been able to locate are the following.
Nearly every one of them is either by Dr. Fekete or is a reaction/amplification/commentary of his writing!
Dr. Fekete himself. For example, he says: "Whenever the government wants to trick people out of their possession of gold, the basis turns negative." (June 23, 2006). And “The gold basis is .... the price of the nearby active futures contract in the gold futures market minus the cash price of physical gold in the spot market.” and “In fact, there is no theoretical limit below which the basis may not go. It may even go negative creating backwardation.” (May 3, 2004). Or in late August 2009 “When the gold basis goes negative, that's the end not only to contango but also to gold futures trading as we know it.”.
Within SILVERAXIS.com - Explanation of Silver Basis we find “..the normal condition for a commodity is to have a positive basis where the futures price is higher than the spot price. This condition is called contango, .....”
There is a most helpful and well-written recent contribution by “Trader” Dan Norcini, an associate of Jim Sinclair, titled Trader Dan Comments On Antal Fekete’s Recent Article . At the end of this article, Dan dares to actually draw a chart of basis. (Thank you, Dan!!) (An aside: It appears that Dan's numbers must be taken with a grain of salt, since he takes Spot gold prices from the “Lease Market” but takes Near Future prices from the “Cash Market”. See the sections on “The Lease Market” and “The Cash Market” here, for my feeble attempt to distinguish these two.)
In a Dec 9 2008 article, by Rob Kirby, we find “When futures are in backwardation, they are said to have a “negative” basis, while in contango – a “positive” basis.”
Peter Cooper here says "Negative basis (backwardation) means ..."
In the Oct 2009 article Gold move not confirmed by backwardation the author, Project Mayhem, initially used the common definition, but RETRACTED it to conform to Dr. Fekete's definition!
A 'Gold Basis Service' newsletter asserts “A good with a high stock to flow ratio should be configured with a positive basis (difference between the future bid and the spot offer) and negative co-basis (difference between the spot bid and future offer) .......”
As of March 2013, the site Monetary Metals offers excellent and current information on gold and silver backwardation but, sadly, propagates the confusion on the definition of basis.
For many purposes this doesn't matter. Kind of like little endian versus big endian, this issue is buried fairly far down inside what most folks want to think about. In particular, there is no similar lack of agreement on the definition of backwardation and of contango.
However, as an example of the
potential to misunderstand what is said about basis we have the
Dr. Fekete has said
"... the shrinking contango and the persistent fall in the gold basis is a measure of the vanishing of gold into private hoards."
This is very clear, given Dr. Fekete's definition of basis.
If on the other hand Dr. Fekete used the definition of basis in general use rather than its negative, the following is a correct interpretation (if rather contorted):
"... the shrinking contango and the persistent fall in the [absolute value of the] gold basis [that is, the continuing rise from more negative to less negative to zero and finally to positive values] is a measure of the vanishing of gold into private hoards."