Situation when futures prices are below the expected spot price at maturity
The graph depicts how the price of a single forward contract will behave through time in relation to the expected future price. A contract in backwardation will increase in value until it equals the spot price of the underlying at maturity. Note that this graph does not show the forward curve (which plots against maturities on the horizontal).
Normal backwardation, also sometimes called backwardation, is the market condition where the price of a commodity's forward or futures contract is trading below the expected spot price at contract maturity.[1] The resulting futures or forward curve would typically be downward sloping (i.e. "inverted"), since contracts for further dates would typically trade at even lower prices.[2] In practice, the expected future spot price is unknown, and the term "backwardation" may refer to "positive basis", which occurs when the current spot price exceeds the price of the future.[3]: 22
The opposite market condition to normal backwardation is known as contango. Contango refers to "negative basis" where the future price is trading above the expected spot price.[3]
Note: In industry parlance backwardation may refer to the situation that futures prices are below the current spot price.[4]
Backwardation occurs when the difference between the forward price and the spot price is less than the cost of carry (when the forward price is less than the spot plus carry), or when there can be no delivery arbitrage because the asset is not currently available for purchase.
In a state of backwardation, futures contract prices include compensation for the risk transferred from the underlying asset holder to the purchaser of the futures contract. This means the expected spot price on expiry is higher than the price of the futures contract. Backwardation very seldom arises in money commodities like gold or silver. In the early 1980s, there was a one-day backwardation in silver while some metal was physically moved from COMEX to CBOT warehouses.[citation needed] Gold has historically been positive with exception for momentary backwardations (hours) since gold futures started trading on the Winnipeg Commodity Exchange in 1972.[5]
The term is sometimes applied to forward prices other than those of futures contracts, when analogous price patterns arise. For example, if it costs more to lease silver for 30 days than for 60 days, it might be said that the silver lease rates are "in backwardation". Negative lease rates for silver may indicate bullion banks require a risk premium for selling silver futures into the market.
^Contango Vs. Normal Backwardation Archived 26 July 2014 at the Wayback Machine, Investopedia
^The curves in question plot market prices for various contracts at different maturities—cf. yield curve
^ abGorton, Gary; Rouwenhorst, K. Geert (2006). "Facts and Fantasies about Commodity Futures" (PDF). Financial Analysts Journal. 62 (2): 47–68. doi:10.2469/faj.v62.n2.4083. S2CID 14880480.
^"Backwardation". Investopedia. Retrieved 21 June 2020.
^Antal E. Fekete (2 December 2008). "RED ALERT: GOLD BACKWARDATION!!!(page 3)" (PDF). Retrieved 20 December 2008.
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