Understanding Contango and Backwardation in Commodity Futures

“So I didn't think you're going to bring that up, But that's the reason we have three exposures. It's complicated, but that mitigates backwardization and contango. And that's just in a nutshell. Let's keep this to you know, thirty or sixty seconds, all right. So when I when I was working at Cargilt, we called the cost of carry, all right, that's canentangle. They both begin with a C. That's how I remember, right, But it's cost of carry.”

“So over time it costs you money to keep that thing on the shelf. So actually, if grocers were really, if they didn't care about the consumer sentiment and just cared about market prices, they would raise the price of that canopeas once in a month, okay. They'd say, well, heck, that cost me a penny more to hold it and pay for heating and air conditioning. And you know it might cost the money. I could earn interest on that money or put it to better use. So the price as you go out the future's curve should go higher because you have to store corn for it's the costs roughly about a nickel a month to store corn, okay. So if you buy corn at four dollars a bushel at the end of a year, you better get four sixty for that corn if you stored it, because it cost you a nickel a month, all right to go out there, So it cost you another sixty cents to hold that corn. If you look at a future's curve, buy and large, that's priced in, all right, that's priced in. So cost of carrier contango is a normal market, all right, prices go up slightly as you go out, just to reflect the cost of buying and holding that commodity.”

“So backwardation is when that breaks, when that system breaks, and that system generally breaks when you when you afraid there's not going to be enough corn that next month, so you buy all your corn this month. Okay, Well, now you've broken the supply demand economics because as more buyers come in, the price goes higher. So if the price nearby goes higher than the price that's further out, that's backwards.”