Backwardation is a term used in bag, in investments, and especially in relation to futures contracts. It can be defined as that situation in which due to a shortage of supply of a certain raw material, or other products or materials, the spot price today is higher than the deferred price. Or, in other words, one of the most important causes of its occurrence is the commodity shortage that affects the spot market.
What is the Backwardation concept?
When using the term backwardation associated with actions, usually refers to the acquisition of a right to delay delivery by paying a percentage by the seller of the shares.
Within the futures contracts, there is talk of backwardation when the futures price is higher the closer the expiration of the contract approached. It should be mentioned that it is the opposite of contango, understanding by the latter, the situation in which the price of futures on a certain product exceeds the expected future spot. That is, in contago, prices fall and tend to the future spot.
When there is backwardation, investors go long to benefit from increases in futures prices until they reach the spot price. For this reason, the futures markets with backwardation are favorable to speculation, as well as to short transactions, being able to obtain profits from arbitrage. Also, when futures are in backwardation, it is often interpreted by investors as a sign of future deflation.
It is important to note that markets do not usually respond the same to the scarcity of everything type of products. Thus, the so-called soft products, such as gas and oil, tend to generate much more movement in the futures markets, including backup wars, compared to other products, for example the typically monetary products such as gold and silver.
The way to look at which futures may experience backwardation is simply to take into account the spread over longer and shorter futures contracts.