gold-eagle.com / By Dr. Tom Fischer / December 19, 2013
After the recent publication of my piece “Fekete’s Arbitrage Fallacy”, I had to endure the wrath of the Fekete camp. However, a week later, I received an email by one of Fekete’s followers, in which an actual argument regarding one of the underlying issues – me negating that backwardation in gold meant arbitrage – was made. Since this argument was flawed, and since it had been put to me before by another person, I analyze it in this essay. To make it brief, besides their shortcomings with regards to arbitrage theory, Fekete’s “New Austrians” seem to ignore the time value of gold, which they should not. Furthermore, I repeat my recent warning to researchers, investors, and hobby economists, that not all is right in Fekete’s theories.
In my article “Faux Gold Arbitrage” from early September, I had given a detailed explanation why backwardation in gold forward markets had nothing to do with arbitrage. In a follow-up titled “Fekete’s Arbitrage Fallacy”, I pointed to the – as far as I can see – main source of this misconception, Antal E. Fekete, and explained the flaws in the definition and the use of the notion “arbitrage” in his writings. The need for this new article, for one, stems from an explanation why backwardation in gold supposedly meant arbitrage, that was given to me recently and that claims to use the standard definition of arbitrage – and not Fekete’s own flawed one. Another reason is that, in this argument, the main intellectual fallacy – namely ignorance towards the time value of money and gold – is one, that I have not explicitly written about before.
The explanation that was put to me – paraphrased in my own words – goes as follows:
Backwardation in gold means that spot gold is more expensive than the forward price. Arbitrage is present when there is the opportunity to instantaneously buy low and sell high. Hence, assuming no counterparty risk, selling cash gold and buying the lower cost future simultaneously represents an arbitrage opportunity.