Backwardation

Don't look back
A new day is breaking
It's been too long
Since I felt this way
--Boston

Backwardation is an unusual situation in futures markets where front month contract prices exceed those of out-month contracts. Usually futures curves slope in the other direction, with out-month prices higher than front month prices (due to carrying costs, etc). This condition is known as 'contango.'

Commonly, backwardation occurs when demand exceeds supply in the near term, leading to shortages. Shortages cause traders to bid up prices of front month contracts but leave farther out futures contracts relatively unaffected. This lends an atypical downward sloping shape to forward futures contract curves, and positive price spreads (i.e., the difference between front month contract prices and out month prices).

As this article reports, backwardation is happening in spades across commodities. While energy-related commodities have been the big headline grabbers, the phenomenon is occurring among other commodity groups. For example, most industrial metals have been in backwardation since late last year.

The glass half full interpretation is that backwardation-causing events are often acute situations that resolve themselves relatively quickly.

The glass half empty interpretation is that backwardation juices prices higher on the upstream ends of supply chains. If they remain persistent, then those pressures tend to work their way downstream to consumers.

Say it, Fed heads: backwardation rhymes with _____.