Explanation
In commodity markets, contango refers to a situation where futures prices are higher than the spot price. This is the opposite of backwardation, where futures prices are lower than the spot price.
Key Concepts:
- Contango: Futures price > Spot price
- Backwardation: Futures price < Spot price
Why Contango Occurs:
- Carrying costs: Storage, insurance, and financing costs for holding the commodity
- Convenience yield: The benefit from holding the physical commodity (typically low or negative in contango)
- Market expectations: Expectations of future price increases
- Supply and demand dynamics: Current oversupply or future scarcity expectations
Implications:
- Contango creates a positive cost of carry for holding commodities
- It can lead to negative roll yields for investors in commodity futures
- Typically associated with markets where storage is possible and carrying costs are significant
This concept is fundamental in derivatives and commodity markets analysis.
