How Contango Changes Commodity Futures Returns
Understand contango and backwardation as price structures across maturities and connect them to futures returns. Avoid treating a rollover price gap as an immediate loss or a guaranteed return.
Contango generally describes a structure in which longer-dated futures are more expensive than spot or nearby contracts; backwardation describes the reverse. This structure affects returns from maintaining commodity futures exposure, but it does not determine future spot prices. In particular, the price gap at the moment of rollover should not itself be interpreted as a realized loss of the same amount.
Separate storage costs from the benefit of immediate ownership
Holding physical commodities for later use can involve financing, warehousing, and other costs. Conversely, if inventory is needed to keep a factory running, immediate physical ownership can be especially valuable. CME’s educational materials explain how these factors relate to the futures curve. However, the curve does not necessarily have a uniform slope across all maturities. For seasonal commodities, intermediate contracts may be the most expensive, so it is more accurate to avoid describing the entire market with one word based only on the nearest and next contract months.
Calculate rollover trades separately from subsequent price changes
When closing a near-maturity contract and opening a longer-dated one, each trade occurs at its prevailing fair market price. The entire price gap does not immediately disappear from the account merely because the longer-dated contract is more expensive. However, if spot stays unchanged while the more expensive futures contract converges to spot at maturity, a loss can arise during the holding period. An index maintaining the same notional exposure may also reduce the number of contracts when moving into a higher-priced maturity. Track actual performance using the index rules and price changes over each contract’s holding period.
Do not treat backwardation as a guaranteed interest-like reward
A lower-priced, longer-dated contract rising toward spot can benefit a long investor, but the overall return can still be negative if spot itself falls sharply in the meantime. Companies that physically use metals design hedges to reduce purchase-price uncertainty rather than pursue such speculative returns. Investors should likewise separate price changes, curve effects, returns on cash collateral, and costs. Predicting long-term returns at a fixed rate from the curve’s shape at one point in time leaves the analysis vulnerable to changing supply and inventory conditions.
Worked example
Hypothetical example: Assume spot is currently $100 and a futures contract maturing in 3 months is $105. If you buy the futures contract at $105 and spot remains $100 at maturity, with futures converging to that price, the loss is $5 per unit. Relative to notional value, the change is 100 ÷ 105 − 1, or approximately −4.76%. The $5 loss was not locked in immediately upon entry: if spot at maturity were $110, the same contract would gain $5 per unit. Costs are excluded.
What to check
- Have you recorded the maturities being compared and the spot reference?
- Have you examined the full curve, including seasonal periods?
- Have you separated contract rollover from price changes during the holding period?
- Have you assessed curve effects alongside commodity price risk?
Sources and primary materials
This is educational material about research methods. For an actual company decision, verify the filings and primary sources for the relevant period.