Dec-Feb futures spread blow out

Tomorrow is first notice day for gold december futures. For those less familiar, first notice day is when those who are long futures contract for the expiring month become eligible to take delivery. Most traders will spread out if they are long December futures, by selling the December they are long and buying some further out month. February is the new active contract, so most spreads done are Dec-Feb. Around noon today I looked at the Dec-Feb futures spread and saw that it was 4.90 bid at 5.00. This is well wider than I had ever seen, so I had to check with one of our traders to see if I was looking at the right thing. His response? "Wow, yea you are, I've never seen it this wide". An hour later, it was as wide as 6.5 (it may have gone a little wider but that is as wide as I saw). I wasn't really sure what it meant, just that the few seasoned traders who were offsite that I mentioned the spread to responded with an exclamatory "WHAT?". So what does this mean?

My friend Howie, who has been on the floor for some time gave me a pretty interesting explanation. I will do my best to paraphrase what he said.

For simplicity's sake lets take the spread at 6 dollars. That is a 2 month spread. So, if you were to extrapolate that to a year, you are paying an annual 36 dollars. Gold trades at approximately 1700 dollars currently. So take the 36 dollars you'd be paying, and divide it by 1700. You get approximately 2.1%. The U.S. ten year yields less than 2%. So, subtract out storage/insurance costs and you'd effectively be getting the same yield by selling the spread (buying December and selling February futures), and taking delivery, over only a two month period.

Howie's conclusion? There is a real drought of liquidity. Traditionally, anytime the spread got this out of whack the bank would just step in and do the trade mentioned above.... especially if you factor in where interest rates are. Why aren't they stepping in? Tough to know. Perhaps the banks are trying to keep as much cash on hand as possible given the macro backdrop. In any event, such action is peculiar, and is worth noting, and paying attention to when February futures expire in two months.