Untangling Contango

Here's why commodities investors need to know this term and its counterpart, backwardation

Adam Zoll 4 October, 2013 | 8:00AM
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Question: I keep hearing the term "contango" in discussions about the commodities markets, but I still can't figure out just what it is or if it's a good thing or a bad thing. Can you help?

Answer: Investors first hearing the term "contango" might guess that it's a variation on an Argentinian dance, but the word actually refers to a condition in the futures markets in which future prices for a given commodity are higher than its current, or spot, price.

For those unfamiliar with how commodities futures work, goods such as wheat, oil and gold are sold at spot prices—the price someone can buy them for today, as well as at future prices—the price someone can pay today for delivery at some date in the future. For example, a food manufacturer who expects to need 5,000 bushels of soybeans in six months can lock in a price today for delivery of those soybeans six months from now. Investors also use futures to speculate as to whether a commodity's price will rise or fall between now and its delivery date.

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About Author

Adam Zoll  is an assistant site editor with Morningstar.com, the sister site of Morningstar.co.uk.