By Andrew Whitelaw | Source: USDA, Trade, CME
In an article last week we discussed the increased acreage likely to be planted to canola, and mentioned that the oilseed market was in backwardation. We were asked by a number of readers to explain in more detail the concept of backwardation and contango.
To read last week’s article click here
The market is in contango when the forward futures price of a commodity is above the spot price. A contango market usually occurs when buyers are more willing to pay more for a commodity in the future than the present. This generally occurs in storable commodity markets, when there is an excess of supply. This typically encourages sellers to hold a commodity rather than sell for a spot price, as a ‘premium’ is paid further out from the spot contract.
At the moment, the wheat market is currently in contango (figure 1). This follows the logic above with the huge global stocks, we would expect the market to be paying more further out as wheat is currently not in favour for spot requirements.
The opposite of contango is backwardation. In a market experiencing backwardation, the forward future months will be priced at a discount to the spot futures market. A market in backwardation suggests that supplies are currently short, and buyers want the commodity now as opposed to the future. In essence this encourages sellers with stocks to sell now rather than hold, as the commodity is discounted in forward contract period.
The oilseed market is currently providing an example of backwardation (figure 2), which again like wheat follows logic with short supplies in recent years encouraging the market to punish sellers from carrying oilseeds.
It has to be noted that although contango points in theory to a bullish market, and backwardation could signal a bearish market as time runs down the spot market could rise or fall dramatically between now and the forward contracts i.e. the canola spot price could continue to remain high.
Knowing whether the market is in contango or backwardation is handy as it gives an indication into the supply and demand picture for a given commodity. It is somewhat an indicator of market direction, if all other factors remained equal, we do however know that that is not regularly the case.
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