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Contango Versus Backwardation

Contango Versus Backwardation
Category: Market Reports
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Posted: 10-07-2015 03:59:00 PM

If the gold market is in a Contango, future price condition means that physical gold is attainable for the most part, and a backwardation will indicate a tightening of supply. The spot price in a backwardated market will have no limits and can trade in large differences to the future months until the metal becomes more available.

A good Wednesday morning to you all. CME Future prices have a story to tell in certain circumstances. Today’s topic: How the spot price can affect future prices.

Let’s examine the difference between a Contango market and a market in backwardation. First lets define the two and describe what I look for when the availability of physical metal gets tight:

  • Contango market: This is a condition where the forward prices exceed the spot price creating an upward curve in pricing.
    Example: December gold $1,100, February gold $1,101, April gold $1,102, June gold $1,103.
  • Backwardation market:This is the opposite condition where forward prices create a downward curve and spot prices exceed the forward prices.
    Example: December gold $1,100, February gold $1,099, April gold $1,098, June gold $1,097.

If the gold market is in a Contango, future price condition means that physical gold is attainable for the most part, and a backwardation will indicate a tightening of supply. The spot price in a backwardated market will have no limits and can trade in large differences to the future months until the metal becomes more available.

Current spot month open interest has a significant effect on the backwardation of the spot price as the days dwindle down to the end of the month, resulting in delivery issues on the exchange.
The old Wall Street guru always says: “There are four things to remember when you begin your career on Wall Street. When entertaining a client, never talk about food, politics or religion and most important, never go into a delivery month with a short position unless you have the metal to deliver.”

We will be watching these levels in the future and report to you any interesting scenarios.

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About The Author

Walter Pehowich Author Name: Walter Pehowich
This editorial has been prepared by Dillon Gage Metals. This document is for information and thought-provoking purposes only and does not purport to predict or forecast actual results. It is not, and should not be regarded as investment advice or as a recommendation regarding any particular security, commodity or course of action. Opinions expressed herein are current opinions as of the date appearing in this editorial only and are subject to change without notice. Reasonable people may disagree about the opinions expressed herein. In the event any of the assumptions used herein do not prove to be true, results are likely to vary substantially. All investments entail risks. There is no guarantee that investment strategies will achieve the desired results under all market conditions and each investor should evaluate its ability to invest for a long term especially during periods of a market downturn. No part of this editorial may be reproduced in any manner, in whole or in part, without the prior written permission of Dillon Gage Metals. This information is provided with the understanding that with respect to the opinions provided herein, that you will make your own independent decision with respect to any course of action in connection herewith and as to whether such course of action is appropriate or proper based on your own judgment, and that you are capable of understanding and assessing the merits of a course of action. You may not rely on the statements contained herein. Dillon Gage Metals shall not have any liability for any damages of any kind whatsoever relating to this editorial. You should consult your advisors with respect to these areas. By posting this editorial, you acknowledge, understand and accept the foregoing.

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